Towards a Level Playing Field: Equality and the Choice of the Legal Form of a Business

Towards a level playing field: Equality and the choice of the legal form of a business

The principle of equality in taxation

Corporate versus non-corporate entities & Permanent establishment versus subsidiary

Sandra Wijnen

Towards a level playing field: Equality and the choice of the legal form of a business

The principle of equality in taxation

Corporate versus non-corporate entities & Permanent establishment versus subsidiary

Tilburg, 20 May 2010

Sandra Wijnen ANR: 368680

Tilburg University Faculty of Economics and Business Administration Department Fiscal Economics

Examination board: Dhr. drs. C.A.T. Peters Dhr. prof. dr. P.H.J. Essers Dhr. prof. mr. E.C.C.M. Kemmeren

Preface

In the course of the academic study of Fiscal Economics at Tilburg University an extensive range of fiscal topics has come across. Upon the eve of writing and completing the Master Thesis, I had to decide my preference for a subject and for a specific project, based upon the previous four years of studying Fiscal Economics. Participating in EUCOTAX Wintercourse in combination with a broad fiscal subject soon became the choice. During preparations for Wintercourse I became familiar with the wide scope of the principle of equality in different law systems, relating them to the Dutch tax system in the light of the choice of the legal form. More importantly, during Wintercourse I learned that equality, or inequality, can imply so many different things. Discussing EUCOTAX Country‟s tax law systems, ventilating opinions on how to cooperate, thinking about boundaries and free competition in the global market, certain similarities but even more so certain differences became clear. The playing field can therefore never be seen from only one perspective. Right and wrong, equal and unequal are hard to point out. This great experience has taught me many things that go far beyond our tax law systems. While finishing this thesis in the Netherlands, it was not that easy to select a feasible amount of information from Wintercourse to incorporate in this thesis. The relatively small amount of available information incorporated in this thesis however shows a fascinating range of perspectives, national legislations and possible approaches to tax related topics. So many other things can additionally be described and evaluated when thinking of alternative ways to approach these tax related topics. Therefore I know our research is not quite done yet and Wintercourse will continue to be a valuable contribution to that research.

Even though I wrote this thesis, a great number of people have contributed to reaching the end result. For that reason I would like to thank those people. Firstly my thesis supervisor, mr. Cees Peters, for discussing this thesis with me and advising wherever needed. Secondly the other Wintercourse supervisors, mr. Essers, mr. Kemmeren, mr. Peeters and mr. Smit, for their valuable comments during our meetings. And at last I would like to thank my TOBAAO colleagues from Deloitte Breda, in whose presence I have written this thesis. Our discussions and your feedback have helped me in the process of writing.

Now all that remains for me is to wish you lots of reading pleasure.

May 2010 Sandra Wijnen

Table of contents

Preface ...... 3 List of abbreviations ...... 6 1. Introduction ...... 8 1.1 Introduction: Equality and the legal form of a business ...... 8 1.2 Research questions ...... 9 1.3 Demarcation ...... 10 1.4 Methodology ...... 10 2 The principle of equality and non-discrimination principle ...... 12 2.1 Introduction ...... 12 2.2 The principle of equality in Dutch constitutional law ...... 12 2.2.1 The principle of equality ...... 13 2.2.2 Ban on judicial review...... 14 2.2.3 Article 94 Constitution ...... 16 2.3 The principle of equality in European law...... 17 2.3.1 Article 49 TFEU ...... 18 2.3.2 Case law on the freedom of establishment ...... 20 2.4 The non-discrimination principle in WTO law ...... 21 2.4.1 Most-favoured nation treatment ...... 21 2.4.2 National treatment rule and free market access ...... 22 2.5 The non-discrimination principle in tax treaties ...... 24 2.6 The principle of equality and non-discrimination principle ...... 26 3. Corporate versus non-corporate entities ...... 28 3.1 Introduction ...... 28 3.2 Qualification of entities ...... 28 3.2.1 Domestic entities ...... 29 3.2.2 Choice? ...... 31 3.2.3 Foreign entities ...... 32 3.3 Double (non-)taxation due to different qualifications ...... 35 3.4 Evaluation: equality and different qualifications ...... 37 3.4.1 Constitutional law ...... 38 3.4.2 European law ...... 38 3.4.3 WTO law ...... 39 3.4.4 Tax treaties (OECD-MC) ...... 39 3.5 Taxation of entities ...... 40 3.5.1 Entities subject to CITA ...... 40 3.5.2 Taxation of (non-)corporate entities ...... 42 3.5.3 Overview ...... 44 3.6 Evaluation: equality and taxation of entities...... 44 3.6.1 Constitutional law ...... 45 3.6.2 European law ...... 46 3.6.3 WTO law ...... 46 3.6.4 Tax treaties (OECD-MC) ...... 47 3.7 Neutral income tax regarding (non-)corporate entities ...... 47 3.8 Conclusion on qualification and taxation of (non-)corporate entities ...... 50 4. Permanent establishment versus subsidiary ...... 53 4.1. Introduction ...... 53 4.1.1 Permanent establishment ...... 53 4.1.2 Subsidiary ...... 54 4.2 Inbound investments ...... 55 4.2.1 Double tax treaty access ...... 56 4.2.2. Profit determination and tax rate ...... 57 4.2.3 The fiscal unity ...... 58 4.2.4 Pooling profits and losses within fiscal unity ...... 60 4

Table of contents

4.2.5 Evaluation: equality and inbound investments ...... 61 4.2.5.1 Equality and double tax treaty access ...... 61 4.2.5.2 Equality and taxation of profit repatriations ...... 62 4.2.5.3 Equality and Dutch PE in group taxation system...... 62 4.3 Outbound investments ...... 64 4.3.1 Cross-border loss relief ...... 64 4.3.2 Evaluation: equality and cross-border loss relief ...... 67 4.4. Funding ...... 69 4.4.1 Funding costs between entities ...... 69 4.4.1.1 Parent company in NL ...... 70 4.4.1.2 Subsidiary in NL ...... 71 4.4.2 Funding costs within entities and internal loans ...... 72 4.4.3 Evaluation: equality, funding costs and internal loans ...... 74 4.5 Conclusion on permanent establishment versus subsidiary ...... 76 5. Qualification methods for foreign entities ...... 80 5.1 Introduction ...... 80 5.2 Qualification of foreign entities ...... 80 5.2.1 Qualification methods – a legal comparison ...... 81 5.2.2 Qualification methods for tax purposes and equality ...... 82 5.3 Hybrid entities and European law ...... 83 5.3.1 Incorporation versus real seat principle ...... 84 5.3.2 Autonomy in classification ...... 86 5.3.3 Art. 293 EC Treaty and the freedom of establishment ...... 88 5.3.4 Mutual recognition ...... 88 5.3.5 Parent-Subsidiary Directive ...... 89 5.4 Solutions in tax treaties ...... 91 5.4.1 OECD Report 1999 ...... 91 5.4.2 Article 24 (4) Treaty NL – USA ...... 93 5.4.3 Protocol I, point 2 and 4 (b) Treaty NL – Belgium ...... 93 5.4.4 Protocol I Treaty NL – Indonesia ...... 94 5.5 Hybrid entities in the neutral level playing field ...... 94 5.5.1 Qualification methods in EUCOTAX Countries ...... 95 5.5.2 Desired alternative...... 96 5.6 Conclusion ...... 98 6. Group taxation systems and cross-border loss relief ...... 101 6.1 Introduction ...... 101 6.1.1 Equality and PE versus subsidiary ...... 101 6.2 Group taxation systems...... 102 6.2.1 Group taxation – a legal comparison ...... 102 6.2.2 Group taxation systems and equality...... 104 6.3 Group taxation systems and European law ...... 106 6.3.1 European case law on group taxation systems ...... 106 6.3.2 EUCOTAX Countries and European case law on group taxation systems ...... 108 6.4 Cross-border loss relief ...... 108 6.4.1 European case law on cross-border loss relief ...... 109 6.4.2 Communication: „Tax Treatment of Losses in Cross-Border Situations‟ ...... 113 6.4.3 Dutch announced territorial system ...... 115 6.5 Group taxation systems in the neutral level playing field ...... 116 6.5.1 Group taxation systems in EUCOTAX Countries ...... 116 6.5.2 Desired alternative...... 118 6.6 Conclusion ...... 120 7. Conclusion ...... 123 Bibliography ...... 131 Jurisprudence register ...... 141 Appendix ...... 146

List of abbreviations

BNB Beslissingen Nederlandse belastingrechtspraak CCCTB Corporate Consolidated Corporate Tax Base CITA Dutch Corporate Income Tax Act 1969 CV(R) Commanditaire vennootschap met Rechtspersoonlijkheid DCC Dutch Civil Code DT Dividend tax DTA Dividend Tax Act 1965 EC European Community EC Treaty Treaty establishing the European Community ECHR European Convention on Human Rights ECJ European Court of Justice EEA European Economic Area EEC European Economic Community EEIG European Economic Interest Grouping EHRR European Human Rights Report EU European Union EUCOTAX European Universities COoperating on TAXes GATS General Agreement on Trade in Services GATT General Agreement on Trade and Tariffs IBFD International Bureau of Fiscal Documentation ICCPR International Covenant on Civil and Political Rights icw in conjunction with LLC Limited Liability Company MBB Maandblad BelastingBeschouwingen NJ Nederlandse Jurisprudentie NL The Netherlands OECD Organization for Economic Cooperation and Development OECD-MC Model Convention of the Organization for Economic Cooperation and Development OV(R) Openbare vennootschap (met Rechtspersoonlijkheid) PE Permanent Establishment PITA Dutch Personal Income Tax Act 2001 SCE European Cooperative Society SE European Company TFEU Treaty on the Functioning of the European Union TFO Tijdschrift Fiscaal Ondernemingsrecht

List of abbreviations

TKN Tax Act for the Kingdom of the Netherlands UK United Kingdom USA United States of America US-MC United States Model Income Tax Convention 1996 VOF Vennootschap onder firma WFR Weekblad Fiscaal Recht WTO World Trade Organization

1. Introduction

1.1 Introduction: Equality and the legal form of a business

The choice of the legal form is one of the most important considerations when starting-up a business. Civil and economic aspects should affect this choice, as tax law should be a neutral aspect in the choice of the legal form of a business. In the abstract a neutral taxation implies a taxation that does not influence the market. In this respect a neutral taxation also does not impact the choice of the legal form of a business. This means that the choice between corporate and non-corporate entities and the choice between a permanent establishment and a subsidiary should not be influenced by tax law. In reality, tax neutrality with respect to the choice of the legal form of a business does not exist.

The Dutch liberalism, as anchored in the Constitution, endorses the freedom of the individual in society. The government has to justify the limitations it places on this freedom by recording these in the law. To implement the fundamental principles into society, the government has to create rules that comply with the norms that define these fundamental principles. The most important fundamental principle in the Netherlands is the principle of equality. On the basis of the principle of equality, the equal and proportional distribution of the burden of taxation is reflected in the ability-to-pay principle.1 In order to realize an equitable taxation in the light of the fundamental principles, tax laws have to limit the freedom and the right of ownership of individuals to a certain justified extent. Distinctions between legal forms on the basis of rules have to be converted into a level playing field that ensures equality between these forms. This level playing field should contain an equal position towards the market for all legal forms of a business, through which competing with each other is possible, starting from a neutral point of departure. The desired level playing field should contain a constant maximization of welfare, an efficient allocation of production factors, a certain state of tax neutrality and capital and labour import neutrality with respect to the market.

To enlarge the neutrality of the choice of the legal form of a business, the principle of equality in taxation has to be reviewed to existing tax law. The principle of equality and the non-discrimination principle in constitutional law, European law, World Trade Organization (WTO) law and tax treaties will be used to evaluate whether issues in Dutch tax law with respect to the choice of the legal form of a business are incompatible with the desired level playing field with a neutral taxation.

1 K. Tipke, Die Steuerrechstordnung, Band 1, Köln: Otto Schmidt 2000, p. 552.

1. Introduction

1.2 Research questions

In this thesis the following research question is handled: ‘How can and should the issues in Dutch tax law in relation to the principle of equality in taxation in constitutional law, European law, WTO law and tax treaties, concerning the choice of the legal form of a business be solved in order to contribute to a more neutral taxation with respect to the choice of the legal form of a business?’

To answer this research question, a number of sub questions are examined. Firstly the scope of the principle of equality in taxation in the different law systems is scrutinized. Then the impact of the principle of equality on Dutch tax law with respect to the choice of the legal form, is used to create a description of the current level playing field, that will prove to lack a neutral taxation. For this purpose the description of the treatment of the legal form of a business will be reviewed to the established scope of the principle of equality in taxation. Two sub questions are therefore:  ‘What is the scope of the principle of equality in taxation in constitutional law, European law, WTO law and tax treaties?’  ‘What are the issues concerning the treatment of the legal form of a business, more specific corporate versus non-corporate entities and permanent establishments versus subsidiaries, based on Dutch tax law in relation to the principle of equality in taxation?’

Through these sub questions a clear oversight of the issues in Dutch tax law in the light of the principle of equality with respect to the choice of the legal form of a business is created. From all of these described issues in Dutch tax law, an internationally interesting selection of topics will be used to further describe the matter of creating a level playing field for the legal forms of businesses. This will be done by a legal comparison of the qualification of foreign entities, group taxation systems and cross-border loss relief with the other EUCOTAX Countries. By this legal comparison similarities and differences between the existing systems are clarified. More importantly, this legal comparison can be a guide to possible solutions for the selected issues. Therefore after the comparison an analysis of which solutions can be provided for the selected topics to come to a more neutral taxation is given. Moreover, the best alternative to reach the desired level playing field with respect to a more neutral taxation for all legal forms of businesses is described. The last two sub questions are:  ‘What similarities and differences can be discovered regarding the selected issues in Dutch tax law between the EUCOTAX Countries?’  ‘What solutions can or should be created to solve the issues in Dutch tax law concerning the choice of the legal form of a business, in Dutch tax law, on a European basis or in a broader way, to contribute to a more neutral taxation?’

1. Introduction

1.3 Demarcation

During the testing of the various aspects of the choice of the legal form of a business to framework of the principle of equality in taxation will become visible that a great number of issues in Dutch tax law can be identified. To limit the research scope of this thesis, not all of these will be discussed while examining solutions towards a more neutral taxation of legal forms. This thesis is limited to the topics concerning different qualification methods for foreign entities, group taxation systems and cross-border loss relief. In the choice of these topics is tried to grasp the largest issues that cover several sub issues that can be linked to these larger issues. Based upon the broad legal comparison, made during the Wintercourse week in Sweden, these selected topics and related problems regarding double (non-)taxation have proven to be present in all EUCOTAX Countries. Regarding the treatment of corporate versus non-corporate entities, classification differences will turn up to cause double (non-)taxation in various situations. On the basis of the legal comparison it will turn out that a lot of EUCOTAX Countries use different qualification methods for foreign entities. By analysing these methods in the light of the principle of equality, an ambiguous solution for the qualification of hybrid entities will turn out to be difficult to realize. Several solutions to prevent double (non-) taxation for hybrid entities will be discussed. Then the aspect of group taxation schemes and cross-border relief will be examined. The legal comparison on both topics will contribute to clarify the international aspects of group taxation systems and cross-border loss relief. In the examination of this last topic is tried to outline possible solutions to reach the desired level playing field containing a more neutral taxation of the different legal forms on the basis of the existing systems in the EUCOTAX Countries. Even though the treatment of a permanent establishment versus a subsidiary entails various other very interesting issues to be solved, this goes beyond the scope of this thesis.

1.4 Methodology

Answering the formulated research questions consists of four steps. Firstly the principle of equality in taxation in the four different law systems is described. A description of successively the principle of equality in constitutional law, the principle of equality and more specific the freedom of establishment in European law, the non-discrimination principle in WTO law and the non- discrimination principle in tax treaties is given. The scope of application of these principles in the field of taxation is stated. Subsequently the choice of the legal form of a business is described with respect to corporate versus non-corporate entities and permanent establishments versus subsidiaries from the perspective of the Netherlands. This description is analysed and evaluated through the testing frame of the

1. Introduction principle of equality in taxation. Even though several issues in the Dutch tax system will be identified in relation to the principle of equality in taxation, not all of these will be addressed while searching for solutions. The following chapters will focus on the different qualification methods for foreign entities, cross-border loss relief and group taxation systems in the search of how solutions can contribute to a neutral level playing field. Therefore thirdly the selected topics in Dutch tax law with respect to the choice of the legal form of a business will be compared to the analysis of the choice of the legal form of a business in the different EUCOTAX countries. By identifying similarities and differences concerning these topics will become clear in which way they can possibly be solved and to what extent a more neutral taxation will be realizable. This is integrated with the final part of the thesis, in which it is addressed how the described topics in Dutch tax law can or should be solved in relation to the principle of equality as laid down in the different law systems. The selected topics will be discussed in more detail, compared to systems in EUCOTAX Countries and possible solutions on the basis of European law, tax treaties or other alternatives will be elaborated. The provided solutions will contribute to a more neutral taxation of different legal forms, so that the desired level playing field for the legal forms of businesses might – at least to some extent – be reached. Finally a summary of these chapters is given, complemented with a conclusion as regards the research question. In this conclusion a recommendation to provide for the described solutions is recorded.

2. The principle of equality and non-discrimination principle

2 The principle of equality and non-discrimination principle

2.1 Introduction

The principle of equality and the non-discrimination principle have an effect on tax law. They embody equal treatment in equal situations and unequal treatment to the extent that situations are unequal. This provides legal certainty for taxpayers. The theoretical framework of the principle of equality and the non-discrimination principle will firstly be used in Chapters 3 and 4 to evaluate the described topics in the Dutch tax system in the light of the principle of equality. This theoretical framework will furthermore be used in later chapters to relate the issues in Dutch tax law concerning the choice of the legal form of a business to tax laws in the other EUCOTAX Countries and additionally to solutions for these issues in the light of the more neutral level playing field. Moreover, it will form a guidance as to which inequalities regarding the choice of the legal form of a business can considered to be justified and which cannot. The principle of equality and the non-discrimination principle are incorporated in several law systems. It plays a role in Dutch constitutional law, European law, WTO law and in tax treaties. In the following chapter the meaning of the principle of equality and the non-discrimination principle in taxation in these different law systems are explained.

2.2 The principle of equality in Dutch constitutional law

The Netherlands (NL) knows a Constitution that is instituted in 1815, Constitution for the Kingdom of the Netherlands of 24 August 1815 (Grondwet voor het Koninkrijk der Nederlanden van 24 augustus 1815, hence: Constitution). Since then, there have been several amendments in the Constitution, the last amendment was in 1983. Besides the Constitution, constitutional law is also formed by written and unwritten rules of law. This written and unwritten law can be named fundamental principles of law.2 In the Dutch Constitution the fundamental principle of equality constitutes the first basic law and is recorded in art. 1: „All persons in the Netherlands shall be treated equally in equal circumstances. Discrimination on the grounds of religion, belief, political opinion, race or sex or on any other grounds whatsoever shall not be permitted.‟3 Furthermore articles relevant for the principle of equality in taxation in the Dutch Constitution are art. 94 and 120, which respectively embody the precedence of provisions of treaties that are binding on all persons or of resolutions by international institutions

2 G.F.M. van der Tang, Grondwetsbegrip en Grondwetsidee (dissertation Erasmus Universiteit, Rotterdam), Deventer: Gouda Quint 1998, p. 9. 3 The phrase „all persons‟ also embodies legal persons and associations without legal personality, next to individuals. See C. van Raad, Non- discrimination in International Tax Law, Deventer :Kluwer 1986, p. 55.

2. The principle of equality and non-discrimination principle and the principle that no Dutch court shall review the constitutionality of Acts of Parliament and treaties. The principle of equality in Dutch constitutional law, its boundaries and its meaning in the light of the international tax context will be explained on the basis of these articles.

2.2.1 The principle of equality The principle of equality in the scope of justice is described in literature as to treat others equivalent the same principles as one wishes to be treated oneself.4 This freedom is restricted by the government at several points. According to the Dutch liberal point of view at society, the limitations that are placed on this freedom by government have to be recorded, and therefore justified, into law.5 In this matter art. 104 Constitution is the base for the lawfulness of taxes, since taxes form a limitation on the freedom of individuals. Art. 104 Constitution: „Taxes imposed by the State shall be levied pursuant to Act of Parliament. Other levies imposed by the State shall be regulated by Act of Parliament.‟ Art. 104 Constitution is the wording of the principle of legality. It contains equality for the law and legal certainty.6 Equality before the law is also known as the formal principle of equality, it obliges a consequent application of the law to all cases. The material principle of equality implies that all have right to an equal treatment by the law without discrimination. The material principle of equality is about the content of legal provisions.7 Since the principle of legality is recorded in the Constitution, it implies legislative supremacy. Tax laws therefore have a strong ground of justification as to limiting the freedom and the right of ownership of individuals and so the principle of equality.

The principle of equality in taxation means that equal cases shall be treated equally and unequal cases shall be treated unequally proportionate to their inequality.8 To determine whether the principle of equality in taxation is applicable in a certain situation, the circumstances for both cases in question are compared. Equal treatment may be required if this is related to the purpose of a certain measure or requirement and if no objective distinctions may be made in the situation under consideration. It is possible to treat equal situations unequally if there is an objective and reasonable justification for unequal treatment. For tax law this means that numerous distinctions between individuals in society are made to create a more justified society, based on political decisions.9 The judiciary weighs these distinctions to the fundamental right of equal treatment and the underlying social norms and decides whether the distinctions are justified. This procedure assures a substantive test for the tax law

4 R.H. Happé, Fiscale Monografieën 77, Drie beginselen van fiscal rechtsbescherming, Deventer: Kluwer 1996, p. 45. 5 This is contrary to the social point of view at society, in which citizens have to justify why the government should not interfere in the freedom of individuals. 6 I.C. van der Vlies, Het wetsbegrip en beginselen van behoorlijke wetgeving, „s-Gravenhage: Vuga 1984, p. 124. 7 R.H. Happé, 1996, p. 49-52 and p. 94-103. 8 This is the classical definition of the principle of equality by Aristotle. 9 Examples of justified distinctions are (non-exhaustive) technical law, budgetary reasons and considerable reasons of efficiency.

2. The principle of equality and non-discrimination principle system.10 The judiciary also has to weigh fundamental principles to each other and in some cases give either the principle of equality or the principle of legality with respect to taxes precedence.11 Unequal cases may be treated unequally to the extent that is justified for that situation. An obvious disproportion in the different treatment of the unequal cases is not allowed.

The principle of equality in art. 1 Constitution has been recorded in the Constitution during the amendment in 1983. Before 1983, the principle of equality also was a fundamental right in NL, but it was an unwritten rule of law.12 The principle of equality has only played a role for taxation since the eighties. In NL it broke through in the process of increasing legal certainty in Dutch jurisprudence in 1979, at the level of the principles of good management.13 Social developments and opinions, international developments, also in the area of human rights, led to this. In international jurisprudence an increasing number of cases passed judgment concerning the principle of equality since the eighties. The influence of international case law on Dutch case law led to the reflection of this breakthrough in the number of appeals in Dutch court since the eighties regarding fundamental rights on the basis of provisions of treaties that are binding on all persons.14 The Dutch Supreme Court bases his decisions on the principle of equality itself, he does not refer to art. 1 Constitution. For Dutch case law the codification of the principle of equality has not made a big difference.

2.2.2 Ban on judicial review Art. 120 Constitution states: „The constitutionality of Acts of Parliament and treaties shall not be reviewed by the courts.‟ This means a ban on judicial review of formal law. Judges are not permitted to test formal law against the Constitution. This does not only embody the articles in the Constitution, it also embodies the unwritten rules of law that belong to the Constitution. This became clear in the Harmonisatiewetarrest in 1989, when the Supreme Court ruled that reviewing formal law to unwritten rules of law was not permitted.15 By this decision the meaning of the principles of proper administration of justice became clear. It still remained possible to test the enforcement of laws in concrete cases, because this does not touch on the binding force of the law which cannot be reviewed.16 The ban on judicial review has the effect that the judiciary can only review other provisions of law than formal laws, also known as general binding regulations or ministerial decrees and bye-laws. The ban on judicial review mainly exists to remain a sharp distinction between the legislative power and the judiciary.17

10 R.H. Happé, 1996, p. 103 and 105. 11 M.A. Wisselink, Fiscale ethiek in beweging. Poging tot begripsvorming, MBB 2001/132. 12 Hoge Raad 1 December 1993, nr. 243, BNB 1994/64. 13 Hoge Raad 6 June 1979, nr. 19290, BNB 1979/211 and later expanded in Hoge Raad 17 June 1992, nr. 27048, BNB 1992/295. 14 These appeals in Dutch court were possible due to the Dutch ban on judicial review in the Constitution in cohesion with the precedence of provisions of treaties that are binding on all persons in the Constitution. This is explained more extensively in paragraph 2.2.3. 15 Hoge Raad 14 April 1989, nr. 13822, NJ 1989, 469 (Harmonisatiewetarrest). 16 Kamerstukken I, 2007-2008, 28 331, nr. E, p. 6 and Kamerstukken II, 2001-2002, 28 355, nr. 2, p 4. 17 This is part of the separation of powers or the three powers of the state from Montesquieu, represented by the legislative power, judiciary and the executive power, embodied in respectively the Parliament, Courts and the administrative machinery. See Hoge Raad 14 April 1989, nr. 13822, NJ 1989 and C. Bruijsten, De verhouding tussen rechtsbeginselen en belastingwetgeving, WFR 2002/715.

2. The principle of equality and non-discrimination principle

It is clear that the legislative power creates law that embodies the meaning and purpose of the Constitution. It might however occur that the legislator cannot foresee all consequences of the law for all individual cases. Just as it is not possible to take future actual developments and changing social views into account while creating legislation. Review by courts can therefore be a useful addition for legal protection of citizens in a specific case and dynamic interpretation of the Constitution.18 Here however has to be taken into account that it is not easy for the legislator to correct an interpretation of a judge by new legislation, since the Dutch procedure for a Constitutional amendment is extremely difficult.19 In the Dutch government debates about the ban on judicial review regularly take place. A few reasonably current Kamerstukken have been discussed in Parliament regarding this subject.20 All propositions have not (yet) made it into an actual amendment of the Constitution. One bill regarding judicial review, namely the „Halsema-bill‟21, has passed the Chambers in first reading. For the bill to be passed and constituted into law, it is necessary to be passed in second reading by the Chambers with a two third majority after dissolution of the first reading government. By this bill it will amongst others become possible for the judiciary to review formal law to the classical fundamental rights, under which the principle of equality in art. 1 Constitution. In law comparing perspective NL is one of only a few countries that still have a ban on judicial review. In Europe the only other country with a ban on judicial review is Britain. Britain is however incomparable to NL, since Britain does not have a written constitution.22 Judicial review, even if only applicable to classical fundamental rights of the Constitution and unwritten rules of law, could increase the legal certainty of individuals.23 Despite the fact that this is an interesting subject for discussion, the fact remains that NL still knows a ban on judicial review to date.

Partly due to the ban on judicial review, the Dutch Constitution is mostly seen as a legal instrument to organize the relations between governmental institutions and society and order the frames and institutions of the formation of law.24 It is a higher construction that is taken into account when creating subordinate law, an abstract frame that is the basis for the legal society.25 It is not so much seen as a living legal instrument in society. An important addition to the above described discussion about the ban on judicial review is that, since the introduction of art. 94 in the Constitution in 1953, statutory regulations can be tested against provisions of treaties that are binding on all

18 Kamerstukken II, 2001-2002, 28 355, nr. 2, p. 4. 19 J. Peters thinks this issue can be solved by simplifying the amendment procedure of the Constitution, see J. Peters, Wie beschermt onze grondwet? (inaugural lecture Universiteit van Amsterdam, Amsterdam), Amsterdam: Vossiuspers UvA 2003, p.21. It is questionable whether this is desirably. 20 Kamerstukken I, 2007-2008, 28 331 and Kamerstukken II 2001-2002, 28 355. 21 Kamerstukken I, 2007-2008, 28 331, Femke Halsema is the politician that submitted this bill. 22 T. Koopmans, Some comparative comments on judicial review, in Judicial Review, Nijmegen 2002, p. 47. 23 J.A.G. van der Geld, Constitutionele toetsing, ook fiscaal van belang, WFR 2002/1035. 24 Barkhuysen, Van Emmerik, Voermans e.a., De Nederlandse Grondwet geëvalueerd, Alphen aan de Rijn: Kluwer 2009, p. 18. 25 It is to be noted that the development of international law, the ban on judicial review and the decreasing social consciousness of the Constitution all contribute to the decrease of the function of the Constitution as to having a binding effect on society, see Barkhuysen, Van Emmerik, Voermans e.a, 2009, p. 21.

2. The principle of equality and non-discrimination principle persons or of resolutions by international institutions. This makes it possible for individuals to call upon fundamental principles recorded in these treaties or resolutions before Dutch court, without the existence of the possibility of judicial review in the Constitution.

2.2.3 Article 94 Constitution Art. 94 Constitution states: „Statutory regulations in force within the Kingdom shall not be applicable if such application is in conflict with provisions of treaties that are binding on all persons or of resolutions by international institutions.‟ Judges can neither test a law to the Constitution, nor to the fundamental rights that are recorded in it. The same fundamental rights however are represented in treaties that are binding on all persons or resolutions by international institutions. Due to art. 94 Constitution it now is possible for Dutch courts to test a law to these fundamental rights. For tax cases art. 26 International Covenant on Civil and Political Rights (ICCPR) or art. 14 European Convention on Human Rights (ECHR) in conjunction with the First Protocol to the ECHR provide a legal basis for individuals in NL with respect to the principle of equality, which can be called upon before Dutch court.26 The number of cases before Dutch Supreme Court regarding the principle of equality in tax law up till today is however still fairly small.27 This is mostly due to the so called „wide margin of appreciation‟ of the fiscal legislator with respect to the principle of equality28 and the fact that the legislator has a broader margin to make objective distinctions in tax cases, because in tax cases the distinction mostly will not be based on personal or fundamental distinctions.29 This wide margin of appreciation is confirmed by the Dutch Supreme Court in 1989, when the Court stated that “a certain margin of appreciation belongs to the legislator in the answer as to whether cases are to be treated equal and, if so, whether nevertheless an objective and reasonable justification exists to lay down different rules for these cases”.30 Another factor of importance that contributes to the low number of appeals regarding the principle of equality in taxation is that the provisions in treaties or resolutions by international institutions are not specialised to fundamental rights in NL.31 Both these factors lead to the fact that the judiciary is extremely reserved as to interpreting the principle of equality in taxation.

All in all art. 94 Constitution is an important increase of legal protection for individuals, but on the one hand the wide margin of appreciation of the fiscal legislator and on the other hand the treaties

26 In 1984 is determined that art. 26 ICCPR has an independent character, so that it has significance for tax law. Art. 14 ECHR merely has an accessory character, but in combination with First Protocol on the ECHR prohibits discrimination in tax cases as decided in EHRR 23 Octobre 1990, nr. 17/1989/177/233 (Darby), BNB 1995/244. See J.L.M. Gribnau, Perspectieven op het gelijkheidsbeginsel, WFR 2000/902 and R.H. Happé, De betekenis van het gelijkheidsbeginsel voor het Nederlandse belastingrecht (not published). 27 R.H. Happé, 1996, p. 390. 28 Confirmed on national level by the Supreme Court in Hoge Raad 12 July 2002, nr. 35900, BNB 2002/399 and Hoge Raad 12 July 2002, nr. 36254, BNB 2002/400, in succession of international case law by the European Court of Human Rights in EHRR 22 June 1999, nr. 46757/99 (Della Ciaja vs. Italy), BNB 2002/398. See also M. Muller, De toekomst van de fiscale rechtsbescherming, Verslag van het symposium ter afscheid van Maarten Feteris, WFR 2008/1231. 29 R.H. Happé, Over trias politica en rechtsbescherming in het belastingrecht, in Rechtsfilosofische annotaties, Nijmegen: Ars Aequi, 2007. 30 Hoge Raad 27 September 1989, nr. 24297, BNB 1990/61 (Tandartsvrouwarrest). 31 J. Peters, 2003, p. 26-28 and M.A.C. van Elk, Draaicirkels van formeel belastingrecht (Vriendenbundel R. Niessen), WFR 2009/1380.

2. The principle of equality and non-discrimination principle or resolutions by international institutions that are not specialised to fundamental rights in NL decrease the optimal effect that the increased legal protection should have. Therefore art. 94 Constitution offers a larger legal certainty, but is not a replacement for the ban on judicial review of art. 120 Constitution.

2.3 The principle of equality in European law

The European Union (EU) was founded in 1992, in succession to the European Economic Community (EEC) of 1957. The European Community (EC) states that its task is to create a common internal market by creating an internal market as laid down in article 3 (2) of the Treaty on the Functioning of the European Union (TFEU)32, providing a regime that guarantees undistorted competition33 and harmonizing direct taxes in different Member States34. This harmonization or neutralization of disparities between the law systems of the Member States with respect to double (non-)taxation is achieved through positive and negative integration.35 Positive integration is integration by means of harmonizing or unifying national laws to the extent that is needed for the working of the internal market.36 Positive integration through harmonization is uniting the working of different national law systems through directives that have to be converted into national law. Co- ordination is the tuning of national law systems to one another, in which diversity and mutual competition between Member States keeps on existing. Since Member States have a great deal of sovereignty with respect to direct taxes due to the required unanimous decisions of art. 115 TFEU, the process of positive integration progresses slowly.37 Co-ordination thus can be easier to accomplish than harmonization, since adjustments to national law systems can be made without unanimous decisions.38 Negative integration is integration through legally enforceable prohibitions on measures that conflict with the internal market, the European Court of Justice (ECJ) plays an important role in this aspect.39 The competition rules of art. 107, 108 and 109 TFEU entail a prohibition for Member States to enforce measures that restrict the free movement in the internal market or to enforce measures that amount to State aid. Therefore negative integration by legally binding decisions made

32 Article 3 (2) TFEU, which came into force at 1 December 2009: The internal market is an area of freedom, security and justice without internal frontiers, in which the free movement of persons is ensured in conjunction with appropriate measures with respect to external borders, asylum, immigration and the prevention and combating of crime. 33 Also confirmed in article 116 TFEU. 34 Article 3 (3) TFEU. Tax law is however the only remaining instrument for national governments to influence their national economy as monetary decisions and policy are disciplines on European level. 35 By using Community law, certain impediments arising from the different law systems of Member States can be erased. See S. van Thiel, Het direct werkende Europese gemeenschapsrecht en het inkomstenbelastingrecht en de belastingverdragen van de lidstaten, TFO 2001/78. 36 A.C.G.A.G. de Graaf, De invloed van het EG-recht op het internationaal belastingrecht: beleids- en marktintegratie, Deventer: Kluwer 2004, p. 16. 37 P.H.J. Essers, De Nederlandse vennootschapsbelasting in Europees perspectief: Overzicht van het harmonisatieproces, WFR 2003/1573. 38 An alternative to positive integration through unanimous decisions is suggested by Stevens in which it would be better to focus on an agreement between a smaller section of Member States that other Member States can join later. See A.J.A. Stevens, Over de afschaffing van belastingverdragen (inaugural lecture, Erasmus Universiteit, Rotterdam), Rotterdam: Boom Juridische uitgevers 2007. 39 A.C.G.A.G. de Graaf, 2004, p. 15-16.

2. The principle of equality and non-discrimination principle by the ECJ is a restriction of the freedom of regulation of Member States through prohibitions, as long as no positive integration is reached through injunctions. The desired internal market is a level playing field that contains a constant maximization of welfare, an efficient allocation of production factors, a certain state of tax neutrality and capital and labour import neutrality. In this level playing field all parties find themselves in the same position towards the market, through which they have an equal point of departure to compete with each other. The goal of the EC is to interfere in the market as far as it is aimed at integrating the different national markets into one internal market. In this light it is relevant that Member States are obliged to exercise their sovereignty while taking the European principles into account, to which national law can be tested.40 Negative integration, especially case law from the ECJ that sometimes interferes with direct taxes, contributes to the reaching of the internal market. This influence might however better be left to the span of positive integration by efforts of the Member States to create fiscal harmonization.41

The internal market enables free cross-border movement of goods, persons, services and capital in the Member States without barriers. For the qualification of entities and the distinctions between permanent establishments and subsidiaries the principle of equality in taxation is translated into the freedom of establishment on the basis of art. 49 TFEU.42 The meaning of the freedom of establishment in the framework of the principle of equality and the case law of the ECJ on this subject are elucidated.

2.3.1 Article 49 TFEU Art. 18 TFEU entails a general prohibition on discrimination on grounds of nationality. Based on case law this prohibition of discrimination is not referred to if another provision is applicable that is more specifically about a prohibition of a certain discrimination.43 Therefore art. 49 TFEU has precedence over art. 18 TFEU. The freedom of establishment means that entrepreneurs, businesses and people with independent professions have to be able to establish themselves in other Member States without any impediments or discriminations. Residents of Member States are free to carry out economic activities in another Member State, regardless whether they are carried out in the form of agencies, branches or subsidiaries. This freedom entails free market access, or a right of cross-border circulation, and market equality, or a prohibition of discrimination on the basis of nationality or origin.44 The freedom of establishment can be restricted by Member States if there is a mandatory requirement of public

40 S. van Thiel, Het direct werkende Europese gemeenschapsrecht en het inkomstenbelastingrecht en de belastingverdragen van de lidstaten, TFO 2001/78. 41 Ch.P.A. Geppaart, Een boekbespreking van De invloed van het EG-recht op het internationaal belastingrecht: beleids- en markintegratie, WFR 2005/129. 42 In the European Community Treaty the freedom of establishment was recorded in art. 43. 43 See ECJ 20 October 1993, C-92/92 (Collins) and H.T.P.M. van den Hurk, Fiscale Monografieën 97, Europees Gemeenschapsrecht en directe belastingen, Spanning tussen verdragsvrijheden en het Nederlands belastingrecht, Deventer: Kluwer 2001, p. 46. 44 B.J.M. Terra and P.J. Wattel, European Tax Law, Deventer: Kluwer 2008, p. 28.

2. The principle of equality and non-discrimination principle interest for the impediment, also known as the rule of reason justifications.45 This freedom is also restricted by the provisions of art. 51 and 52 TFEU, in which is stated that the freedom of establishment is not applicable to activities connected with the exercise of official authority and requirements for special treatment for foreign nationals on ground of public policy, public security or public health. To determine whether a certain impediment is justified by a rule of reason, a list of questions can be followed.46 An objective justification for an impediment exists (1) if no harmonization of that certain area at EC level exists, (2) if the measure does not distinct (directly) on the basis of nationality, (3) if the measure provides equivalent protection of the public interest, (4) if the restrictive measure is appropriate for the protection of the public interest involved and (5) if the measure is proportionate in its restrictive effective measures the legitimate aim pursued. To the fourth question can be added that public interest for tax matters is accepted by the ECJ as the effectiveness of fiscal supervision, the need to maintain the integrity of the tax system, also known as fiscal coherence, and the need to prevent abuse of EC law.47 In the freedom of establishment both discriminations and restrictions can be distinguished. The interest of the distinction between discriminations and restrictions lays in the grounds of justification for these. Discrimination sees to cases where measures distinguish between domestic and foreign economic entrepreneurs or goods. Discrimination mostly occurs when national treatment is not given to non-residents.48 Restriction sees to cases where restrictive measures without distinction lead to an impediment.49 Justifications for discriminating measures, or distinguishing measures, are to be found in written exceptional grounds as they are constituted in the TFEU as justifications for restrictive measures, or measures without distinction, also include unwritten exceptional grounds, such as the exceptions in the rule of reason.50 The freedom of establishment has turned out to be of significant effect on national tax law as it led to a lot of adaptation in national tax law through case law of the ECJ on this freedom.51

45 The ECJ summarized the criteria for application of the rule of reason in ECJ 30 November 1995, C-55/94 (Gebhart). 46 The list is recorded in B.J.M. Terra and P.J. Wattel, 2008, p. 32-34. The questions are freely adopted. 47 B.J.M. Terra and P.J. Wattel, 2008, p. 32-33. This includes their references to ECJ 20 February 1979, C-120/78 (Cassis de Dijon), ECJ 15 May 1997, C-250/95 (Futura Participations) and ECJ 28 January 1992, C-204/90 (Bachmann). Furthermore E.C.C.M. Kemmeren has stated some other justifications that are included in the public interest: the principle of territorialism, the countering of tax avoidance, the balanced distribution of taxing competence of Member States, the prevention of double non-taxation, to ensure a good working of source taxation, the promotion of research and development, the continuation of agricultural and forestry undertakings with succession, the continuing existence of employment with agricultural and forestry undertakings with succession and the protection of the quality of education. 48 One example in which this discrimination occurred in reverse, where residents were treated less favourably than non-residents, and was held not in accordance with European law is Commerzbank, see ECJ 13 July 1993, C-330/91 (Commerzbank). This decree made clear that a disguised form of discrimination existed for the fiscal criterion of establishment in another Member State as a condition for receiving a tax exemption for interest payments. No justification could be found in the fact that only non-residents of the United Kingdom could claim this tax exemption, it was still discriminating. Note that this does however not imply that residents may never be treated less favourably than non-residents. 49 B.J.M. Terra and P.J. Wattel, 2008, p. 43. 50 H.T.P.M. van den Hurk, 2001, p. 85 and Fiscale Encyclopedie De Vakstudie, Nederlands Internationaal Belastingrecht, onderdeel 4, Algemeen commentaar, aantekening 8.3, Non-discriminatie naar nationaliteit en de vier vrijheden, Rechtvaardigingsgronden. 51 For example, one of the earliest decrees from the ECJ with an effect on direct taxation is Avoir Fiscal, see ECJ 28 January 1986, C-270/83 (Avoir Fiscal). Herein was decided that if a Member State does not make a distinction between domestic and foreign taxpayers for national basis of assessment or tariff, it is not allowed to make a distinction for another area. This meant in this case that the avoir fiscal, a tax credit, that was only granted to businesses established in France should also be granted to permanent establishments in France, since French tax law did not distinct between domestic and foreign taxpayers for national basis of assessment or tariff.

2. The principle of equality and non-discrimination principle

2.3.2 Case law on the freedom of establishment Regarding the freedom of establishment a lot of cases have passed judgment by the ECJ. The influence on direct taxation has slowly grown, up till the point that all Member States have to take this jurisprudence into account in their national legislation despite their sovereignty in direct taxes. An exhaustive discussion of case law from the ECJ on the freedom of establishment goes beyond the scope of this thesis.52 Several decrees of the ECJ that clarify the principle of equality in the light of the freedom of establishment are however important for the continuation of this thesis. These will be discussed in the relevant sections of the text.53

The ECJ states in most of its rulings that direct taxes belong to the jurisdiction of Member States as long as these are exercised in accordance with community law. Based on the amount of case law that has come up with respect to the freedom of establishment in which an impediment is assessed, it is clear that community law does have a great deal of impact on national tax law. In the development of the case law of the ECJ on the freedom of establishment the permanent establishment in the host state has acquired an equal situation as to domestic taxpayers, at least when they are in comparable situations regarding economic activities and subject to the same tax legislation.54 Different treatment of the permanent establishment in comparison with the subsidiary by the host state is however accepted when the situations objectively justify different tax treatment.55 With respect to the home state it holds that the latter state may not restrict establishment in another Member State, it does however not have to treat foreign permanent establishments the same as foreign subsidiaries.56 Thus on the one hand case law created great similarities between the tax treatment of permanent establishments and subsidiaries, while on the other hand there also seems to be a boundary to this equal treatment within case law. In the continuation of this thesis will be examined whether this area of equality or just the boundaries regarding this equal treatment between these legal forms, indicated by the ECJ, is sufficient or has to be complemented with European legislation in order to reach the desired neutrality within taxation of the different legal forms.

52 For an extensive discussion about case law of the ECJ on the freedom of establishment is referred to H.T.P.M. van den Hurk, 2001, p. 112-140 and Fiscale Encyclopedie De Vakstudie, Nederlands Internationaal Belastingrecht, onderdeel 4, Algemeen commentaar, aantekening 8, Non-discriminatie naar nationaliteit en de vier vrijheden. 53 Judgments that will pass in review are for instance amongst others ECJ 21 September 1999, C-307/97 (Saint-Gobain), ECJ 13 December 2005, C-446/03 (Marks & Spencer II), ECJ 6 December 2007, C-298/05 (Columbus Container Services), ECJ 28 February 2008, C-293/06 (Deutsche Shell GmbH), ECJ 15 May 2008, C-414/06 (Lidl Belgium), ECJ 23 October 2008, C-157/07 (Krankenheim Ruhesitz am Wannsee) and ECJ 25 February 2010, C-337/08 (X Holding BV). 54 This also comes back in several decrees such as for instance ECJ 28 January 1986, C-270/83 (Avoir Fiscal), ECJ 13 July 1993, C-330/91 (Commerzbank) and ECJ 29 April 1999, C-311/97 (Royal Bank of Scotland). In Royal Bank of Scotland it became clear that a deficit treatment of permanent establishments in contrary to entities established in that State in principle leads to an infringement on the freedom of establishment. This saw to a higher tariff that was applicable to permanent establishments in that State from foreign entities and was discriminating with respect to the lower tariff that was applicable to domestic entities. See also H.T.P.M. van den Hurk, 2001, p. 139-140. 55 See F.C. de Hosson, Het onderscheid vaste inrichting – dochtervennootschap bezien vanuit gemeenschappelijk perspectief, WFR 2003/1581. See also P.J. Wattel, Corporate tax jurisdiction in the EU with respect to branches and subsidiaries; dislocation distinguished from discrimination and disparity; a plea for territoriality, EC Tax Review 2003/4. 56 The ECJ has recently confirmed this view in ECJ 25 February 2010, C-337/08 (X Holding BV). With respect to the general statement see also P.J. Wattel, Corporate tax jurisdiction in the EU with respect to branches and subsidiaries; dislocation distinguished from discrimination and disparity; a plea for territoriality, EC Tax Review 2003/4.

2. The principle of equality and non-discrimination principle

2.4 The non-discrimination principle in WTO law

The World Trade Organisation (WTO) was founded in 199557, but goes back to 1947, when several Western countries concluded the General Agreement of Trade and Tariffs (GATT).58 The purpose of the GATT is to make free trade possible, take away barriers to trade and eliminate import- and export tariffs.59 All agreements that are made by the Members of the WTO are binding on all Members.60 The decision-making regarding agreements or negotiations goes by means of consensus or otherwise through voting by majority based on art. 9 paragraph 1 in the Agreement establishing WTO. If a conflict between two members arises, they can make a complaint to the Dispute Settlement Body, which will state a binding judgment.61 The GATT enshrines that no discrimination in international trade may take place. This non- discrimination principle consists of both the most-favoured-nation treatment and the national treatment clause, in respectively art. I and III GATT. Simultaneously with the founding of the WTO, the Members concluded the General Agreement on Trade in Services (GATS).62 The purpose of the GATS is to liberalise services by taking away barriers and opening markets. The GATS has horizontal obligations applying to all service sectors and vertical obligations applying to specific sectors. The most important horizontal obligation is the most- favoured nation treatment. The most important vertical obligations are the national treatment rule and free market access. The non-discrimination principle in WTO law will be elaborated and the extent of the effect of this principle on direct taxes. Furthermore the relevancy in the framework of the principle of equality in taxation will be discussed.

2.4.1 Most-favoured nation treatment The most-favoured nation obligation implies that each foreign country should have the same rights to the market they are both active on, no distortions to the comparative advantages of these countries may exist.63 The most-favoured nation treatment is recorded in both the GATT and GATS. The scope of the most-favoured nation treatment in art. I GATT is limited to the trade in goods, since this is the subject of the Agreement.64 The GATT refers to internal taxes and internal regulation applied to products.65 Van Thiel states that this also sees to income taxes, since they qualify as “law, regulations and requirements affecting the internal sale of products, or their offering for sale,

57 Agreement establishing the World Trade Organization of 1 January 1995. 58 General Agreement on Tariffs and Trade of 30 October 1947. 59 In M. Lang, J. Herdin and I. Hofbauer, WTO and Direct Taxation, Vienna: Linde 2005, p. 15 this is called the maintaining and further developing of an open rules-based system of international trade. 60 The European Union counts as one member of the WTO. The WTO knows more than 140 member countries today. 61 See art. III paragraph 3 Agreement establishing WTO in conjunction with Annex 2 Understanding on rules and procedures governing the settlement of disputes of the Agreement establishing WTO. 62 Annex 1B General agreement on trade in services of the Agreement establishing WTO of 1 January 1995. 63 M. Lang, J. Herdin and I. Hofbauer, 2005, p. 18. 64 C.A.T. Peters, National Report Netherlands in M. Lang, J. Herdin and I. Hofbauer, 2005, p. 502, 503. 65 M. Lang, J. Herdin and I. Hofbauer, 2005, p. 19, 20.

2. The principle of equality and non-discrimination principle purchase, transportation, distribution or use”.66 He furthermore states that in general the effect of direct taxes on international trade is not large because income taxes generally do not relate to trade in goods. Therefore the GATT does not play a particular large role in the relation of the non- discrimination principle in taxation. The GATS sees to trade in services.67 Art. II paragraph 1 GATS states that: „With respect to any measure covered by this Agreement, each Member shall accord immediately and unconditionally to services and service suppliers of any other Member treatment no less favourable than that it accords to like services and service suppliers of any other country.‟ In other words this means that if one country gets certain favourable trade conditions, all other countries have the same rights to these conditions. Art. II paragraph 3 GATS includes an important allowance of restriction of the non-discrimination principle: „The provisions of this Agreement shall not be so construed as to prevent any Member from conferring or according advantages to adjacent countries in order to facilitate exchanges limited to contiguous frontier zones of services that are both locally produced and consumed.‟ This is applicable to the free trade zone with respect to import- and export rights in the European Union. The EU does not have to acknowledge this free trade to all other WTO Members through the working this provision. The definition of trade in services in the GATS is very broad. Therefore the potential scope of influence on direct taxation, as far as they affect trade in service, is large.68 Even though direct taxation falls within the scope of the GATS, the effect of the non-discrimination principle on direct taxation is limited. This is due to the recorded extensive exemptions for direct taxation in art. XIV GATS. This is connected to the scope of the national treatment rule.

2.4.2 National treatment rule and free market access National treatment is represented in art. III GATT and art. XVII GATS. It contains a prohibition of discrimination by WTO Members for foreign versus domestic suppliers. The scope of the effect of the national treatment in the GATT to direct taxation is limited equal to the most-favoured nation treatment. For the GATS this is somewhat different. The national treatment clause in the GATS gives WTO Members the possibility to commit to this treatment on the basis of selective market access.69 NL has committed itself to the national treatment rule in GATS with respect to financial services.70 Art. XVII paragraph 1 GATS states: „(…) each Member shall accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favourable than that it accords to its own like services and service suppliers.‟ Hereby has to be said that the use of tariffs to protect the domestic industry is allowed, because national treatment only

66 Van Thiel, General Report in M. Lang, J. Herdin and I. Hofbauer, 2005, p. 20. 67 C.A.T. Peters, National Report Netherlands in M. Lang, J. Herdin and I. Hofbauer, 2005, p. 503. 68 C.A.T. Peters, National Report Netherlands in M. Lang, J. Herdin and I. Hofbauer, 2005, p. 504 and art. I paragraph 2 GATS. See also Van Thiel, General Report in M. Lang, J. Herdin and I. Hofbauer, 2005, p. 35, 36. 69 Van Thiel, General Report and C.A.T. Peters, National Report Netherlands in M. Lang, J. Herdin and I. Hofbauer, 2005, respectively p. 35 and p. 509. 70 Schedule of Specific Commitments, Supplement 4, revision 18 November 1999, GATS/SC/31/Suppl.4/Rev.1.

2. The principle of equality and non-discrimination principle applies once a service or service supplier has entered the market. The national treatment rule prevents Members from taking hidden domestic barriers to trade by according imported services and products less favourable than accorded to domestic services and products.71 These hidden domestic barriers to trade are taxes and regulations, that can have a disturbing effect on free trade. Domestic services and products should not be protected by affecting imported services and products through national taxes and regulations. The national treatment rule is agreed on by the WTO with consideration of certain exceptions, which are described in art. XIV GATS and art. XVII paragraph 2 and 3 GATS. The most important exceptions are the allowance of government procurement and payment of subsidies exclusively to domestic service suppliers and producers. Furthermore countries are bound to the national treatment rule, but they can make distinctions between domestic and foreign services suppliers and producers as long as these distinctions are not less favourable for foreign suppliers and producers compared to domestic suppliers and producers. This is related to the extent of free market access that countries are allowed to determine themselves.72 This leaves room for national preferences and policy.73 If there is a discrimination to a foreign service supplier of producer, this is mostly am implicit effect of certain taxes or regulations, related to more effort and higher costs for the foreign service supplier or producer to meet domestic rules.74 This makes it difficult, especially taking the broad exception for taxes in art. XIV sub d GATS in account, to counter these discriminating measures. Furthermore the combination of art. XIV sub c and e GATS creates the possibility for countries to conclude bilateral treaties with differently applied measures to avoid double taxation to foreign investors.

Concluding can be said that the non-discrimination principle in WTO law is represented by the most-favourable nation treatment and the national treatment rule. The scope of these clauses in the GATT are of no relevant impact on direct taxation. These clauses in the GATS have a broad potential impact, due to the large definition of services in the Agreement. The extensive exceptions in the GATS however result in a broad range of determination for countries to decide whether or not to implement certain rules regarding taxation. Furthermore tax treaties between countries do not fall under the scope of WTO law. This limits the scope of effect of the non-discrimination principle in WTO law on direct taxation. This limited scope leads to a small interest of the non-discrimination principle WTO law in the field of taxation. Therefore this law system is only referred to on a very limited basis in the following of this thesis.

71 For example by reducing an import tariff for certain services and products and at the same time imposing domestic consumption tax on these imported services and products. 72 This is different for each country, it belongs to the vertical obligations. 73 H. Kox and A. Lejour, CPB Document nr. 51, Een nieuwe WTO-ronde voor diensten, Mogelijke gevolgen voor Nederland, Centraal Planbureau 2004, p. 16. Kox and Lejour give an example that explains the national treatment rule: The number of domestic licenses for financial services may be restricted by a country. If the number of foreign licenses for financial services is restricted, this is an impediment of the national treatment rule. It is however allowed to limit the number of licenses for domestic and foreign financial services together. In practice the effect will still be that there will be more domestic financial service suppliers, but there is no discrimination. 74 H. Kox and A. Lejour, 2004, p. 67-69.

2. The principle of equality and non-discrimination principle

2.5 The non-discrimination principle in tax treaties

NL has an extensive network of tax treaties with countries all over the world.75 These treaties differ somewhat from each other, but show great similarity, since they are all based on the Model Convention of the Organization for Economic Cooperation and Development of 2008 (hence: OECD- MC). 76 In the discussion of the non-discrimination principle in tax treaties therefore the OECD-MC will be used. The OECD-MC is not a binding legal instrument, it is a guideline for countries in designing tax treaties, which serves as a basis for negotiation, application and interpretation of tax conventions.77

Art. 24 OECD-MC describes non-discrimination and can be divided into two sorts of discrimination. The first is discrimination on the grounds of nationality in paragraphs 1 and 2, respectively seeing to nationality-based discrimination and stateless persons. The second discrimination is on the grounds of residence in paragraphs 3, 4 and 5, respectively seeing to permanent establishment discrimination, foreign creditor discrimination and foreign control of discrimination. Non-discrimination with respect to nationality means that „nationals of the other contracting state shall not be subjected to any taxation which is more burdensome than taxation to which nationals of the other state in the same circumstances are or may be subjected‟ (art. 24 paragraph 1 OECD-MC). The distinction between domestic and foreign taxpayers thus is justified for they do not find themselves in the same circumstances. In the Commentary on article 24, paragraph 1, nr. 17 this is explicitly said: „The different treatment of residents and non-residents is a crucial feature of domestic tax systems and of tax treaties.‟ With respect to this nationality-based discrimination a decision of the Dutch Supreme Court is relevant.78 In this decree the Dutch tax authorities excluded a company, established in the Netherlands Antilles and with the effective place of management in NL, from the Dutch fiscal unity rules. The tax authorities stated that the company was not incorporated under Dutch tax law and that the distinction for the company incorporated under foreign tax law therefore was justified.79 The Supreme Court ruled that due to the fact that the company had its effective place of management in NL, it was unlimited liable to tax in NL and the distinction was not justified.80

75 For an overview of these tax treaties see C. van Raad, Teksten Internationaal & EG belastingrecht 2009-2010, Deventer: Kluwer 2009. 76 C. van Raad, Cursus Belastingrecht, Internationaal belastingrecht, Kluwer: Deventer 2009, sections 3.1.1.C and 3.2.0. See also C.A.T. Peters, Non-discrimination at the crossroads of international taxation – Dutch Branch Report in L. Hinnekens & P. Hinnekens, Non- discrimination at the crossroads of international taxation (p. 407-426), Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2008. (Cahiers de Droit Fiscal International, Volume 93a), p. 409-411, where some of the differences between the OECD-MC and specific Dutch double tax treaties regarding non-discrimination are elaborated. 77 Application and interpretation of article 24 (non-discrimination), Public discussion draft, OECD, Paris, 2007, p. 2. 78 Hoge Raad 16 March 1994, nr. 27764, BNB 1994/191. 79 C.A.T. Peters, 2008, p. 412. 80 C.A.T. Peters, 2008, p. 413: This decision is in line with the conclusion of the OECD-MC working group in Application and interpretation of article 24 (non-discrimination), Public discussion draft, OECD, Paris, 2007, p. 7. Stated is: „Paragraph 1 may still be applicable to resident companies subject to unlimited taxation who are simply not incorporated in that state.‟

2. The principle of equality and non-discrimination principle

In the light of this decree NL however does make a distinction that might be named a discrimination in the light of art. 24 paragraph 1 OECD-MC. The fiscal unity rules of art. 15 of the Dutch Corporate Income Tax Act 1969 (Wet op de vennootschapsbelasting 1969, hence: CITA) are applicable to entities established under Dutch law. To eliminate the nationality-based discrimination in this provision, an amendment made art. 15 CITA also applicable to foreign entities under certain prescribed circumstances.81 These circumstances demand in art. 15 paragraph 3 sub d CITA that an entity is actually established in NL, judged by the effective place of management, is incorporated under the law of the Netherlands Antilles, Aruba, a Member State of the EU or in a state with which NL has concluded a double tax treaty with a nationality-based non-discrimination clause and its legal form is sufficiently comparable to one of the eligible Dutch legal forms. The demand that an entity has to be actually established in NL might form a discrimination in the light of art. 24 paragraph 1 OECD-MC, since a discrimination on the basis of nationality arises here.82 A similar discriminating provision is art. 28 CITA, which sees to fiscal investment institutions.83 Non-discrimination with respect to residence amounts to the same effect of treating domestic and foreign taxpayers the same if they are in the same circumstances. Van Raad states that this non- discrimination clause is often violated by states that follow the system of deduction for profits of permanent establishments from foreign entities.84 This goes also for the limited deductibility of interest and royalties paid by permanent establishments to head offices. The above mentioned criteria with respect to the place of establishment for foreign entities in art. 15 and 28 CITA also imply a discrimination on the basis of art. 24, paragraph 3 OECD-MC.

In the Commentary on article 24 concerning non-discrimination, general remarks, nr. 1, can be found that the article deals with the elimination of tax discrimination in precise circumstances, that is when all factors are equal and the different treatment is solely based on the difference that is prohibited by a provision. The article does not cover indirect discrimination.85 The Dutch courts endorse this point of view.86 Furthermore the principle of non-discrimination in this article does not ensure the most-favoured nation treatment. This means that third parties cannot claim benefits arising from a double taxation convention between two other states, by reason of a non-discrimination provision between the third party and one of the two states with the double taxation convention. It does however cover national treatment, as to be read in the Commentary in paragraph 1. The national treatment rule is worded as

81 See art. 15 paragraph 3 sub c and d in conjunction with paragraph 4 CITA. For a more extensive elaboration see Q.W.J.C.H. Kok, Fiscale Wetenschappelijke Reeks 5, De fiscale eenheid in de vennootschapsbelasting, Amersfoort: Sdu Fiscale & Financiële Uitgevers 2005, p. 108- 112. 82 In C.A.T. Peters, 2008, p. 413, is explained that it is also questionable whether this is in line with the fundamental freedoms of the TFEU. The advice to refer to the ECJ has been followed and a preliminary ruling has been requested by the Dutch Supreme Court. 83 C. van Raad, 2009, section 3.5.1.b. 84 C. van Raad, 2009, section 3.5.1.c. 85 Indirect discrimination arises when a tax measure does not distinguish between domestic and foreign taxpayers, but it does have a discriminating effect due to the application of it. 86 C.A.T. Peters, 2008, p. 414.

2. The principle of equality and non-discrimination principle follows: „Discrimination on the grounds of nationality is forbidden and, subject to reciprocity, the nationals of a Contracting State may not be less favourably treated in the other Contracting State than the nationals of the latter State in the same circumstances.‟

2.6 The principle of equality and non-discrimination principle

The scope of the principle of equality and the non-discrimination principle in taxation have been explained in the previous paragraphs. It has slightly different effects in the four different law systems that are taken into account. In constitutional law the principle of equality is recorded in art. 1 Constitution since 1983, but before that it had the same meaning by working of the rules of unwritten law. The judiciary cannot test formal laws to this fundamental right, hence art. 120 Constitution embodies a ban on judicial review. This ban on judicial review extends to the prohibition of reviewing formal laws to the rules of unwritten law, based on a ruling of the Dutch Supreme Court.87 Since the eighties, art. 94 Constitution became of influence on Dutch case law concerning the principle of equality. Appeal to provisions of treaties that are binding on all persons or of resolutions by international institutions by individuals before court, made it possible for Dutch courts to test laws to fundamental rights. However, due to the wide margin of appreciation of the fiscal legislator and the fact that treaties and resolutions by international institutions are not specialised to specifically protect the fundamental rights as laid down in the Dutch Constitution, the increased legal protection through art. 94 Constitution is not a replacement for the ban on judicial review. In the EU the process of harmonization or neutralization of disparities between Member States with respect to double (non-)taxation is achieved through positive and negative integration. Negative integration by legally binding decisions made by the ECJ is a restriction of the freedom of regulation of Member States through prohibitions, as long as no positive integration is reached through injunctions. The process of positive integration progresses slowly due to the required unanimous decisions regarding direct taxes of art. 115 TFEU. In European law the freedom of establishment of art. 49 TFEU is reviewed. This freedom means that entrepreneurs, businesses and people with independent professions have to be able to establish themselves in other Member States without any impediments or discriminations. The freedom of establishment can be restricted if there is a justified rule of reason for the impediment or by activities connected to the exercise of official authority, special treatment of foreign nationals on grounds of public policy, public security or public health.88 Case law from the ECJ on the freedom of establishment has had a great deal of impact on national tax law. The freedom of establishment has

87 Hoge Raad 14 April 1989, nr. 13822, NJ 1989, 469 (Harmonisatiewetarrest). 88 Art. 51 and 52 TFEU.

2. The principle of equality and non-discrimination principle developed into the situation that the host state has to grant similar treatment to permanent establishments and subsidiaries, except where the situations objectively justify different tax treatment. The home state may on the basis of the freedom of establishment not restrict establishment of an entity in another Member State, but does not have to grant the same tax treatment to both foreign permanent establishments as foreign subsidiaries. The non-discrimination principle in WTO is represented by the most-favoured nation treatment and the national treatment rule. Most-favoured nation treatment means that if one country gets certain favourable trade conditions, all other countries have the same rights to these conditions. The national treatment rule ensures that a country has to treat domestic and foreign services and service suppliers equally. The GATT has no relevant impact on direct taxation, since the Agreement sees to the trade of goods. The GATS however does have a potential impact on direct taxation, due to the broad definition of the term services. The national treatment rule in the GATS only has a working once a service or service supplier has entered the market. In the area of direct taxation broad exceptions exist, also with respect to the most-favoured nation treatment. This limited scope leads to a small interest of the non- discrimination principle WTO law in the field of taxation. Therefore this law system is only referred to on a very limited basis in the following of this thesis. In the OECD-MC art. 24 elaborates about non-discrimination. This non-discrimination principle entails the national treatment rule. It does not extend to the most-favourable nation treatment, so that the working of double tax conventions between two countries cannot be enforced by a third country. The national treatment rule forbids discrimination on the grounds of nationality or residence if subjects are in equal circumstances.

In general the principle of equality in taxation thus implies a broad range of interpretations in these four different law systems. In the following two chapters a description of topics concerning corporate versus non-corporate entities and permanent establishments versus subsidiaries will follow, which will be evaluated in the light of the theoretical framework of this chapter. In the succeeding two chapters the specific topics chosen from the broad description will be compared to the other EUCOTAX Countries, also in the light of this theoretical framework. Moreover, it will be used as a guidance to view certain topics in perspective and when discussing solutions for the selected topics, to place those in the view of the desired neutral level playing field.

3. Corporate versus non-corporate entities

3.1 Introduction

In this chapter a comparison will be made between corporate entities and non-corporate entities from a Dutch law perspective. Firstly the qualification of entities will be discussed. This will be done by describing the criteria that are used for qualification, for both domestic entities and their ability to choose for corporate personality, as well as for foreign entities. Regarding foreign entities will be clarified to what extent NL accepts their qualification under foreign law. Furthermore will be described how NL copes with double (non-)taxation as a result of different qualifications of entities under domestic and foreign law. Also the impact of the principle of equality in constitutional law, European law, WTO law and tax treaties on different qualification of entities will be evaluated. For this the theoretical framework of the previous chapter will be used. Next the taxation of entities will be described. It will be elaborated which entities are subject to Dutch corporate income tax and the criteria that serve as a basis for subjection. An overview of some of the main differences between the taxation of corporate and non-corporate entities if shareholders or partners are subject to either personal income tax or corporate income tax, for both residents and non- residents is given. Then the impact of the principle of equality in constitutional law, European law, WTO law and tax treaties on the treatment of (non-)corporate entities is described and shortly evaluated. Finally a reflection of the discussion in Dutch literature concerning the desirability and the feasibility of neutral taxation of corporate and non-corporate entities is reported. Finally the conclusion will follow. This chapter will give a clear insight of the Dutch tax system and its issues on corporate versus non-corporate entities in the light of the principle of equality. It will contribute to the final ability to judge whether the impact of tax considerations on the choice of the legal form should be more neutral in the light of the principle of equality, more specified to corporate versus non-corporate entities.

3.2 Qualification of entities

In NL the Dutch Civil Code (hence also: DCC), Book 2, qualifies and elaborates about entities. A precise definition of a legal entity does not exist. Some characteristic qualities of a legal entity can however be distinct: „A separate capital with own liability and an own existence, and a purpose that is not bound to the existence and the individual interests of certain persons‟.89 In the legal qualification of an entity a distinction can be made between public or private corporate entities. A public entity is

89 M.L.M. van Kempen, Rechtspersoonlijkheid en belastingplicht van vennootschappen, Deventer: Tjeenk Willink, 1999, p. 1.

3. Corporate versus non-corporate entities incorporated by an official deed by the government and a private entity is created by an agreement between parties. Public entities are listed in art. 2:1 (1) DCC90: „State, the provinces, the municipalities, the water control corporations and all bodies which under the Constitution have the power to issue regulations possess legal personality.‟ Private entities are listed in art. 2:3 DCC: „Associations, cooperatives, mutual insurance societies, companies limited by shares, private companies with limited liability and foundations possess legal personality.‟ Besides these corporate entities in the DCC in Book 2, numerous organisations are granted corporate personality by special law.91 In the different existing theories concerning corporate personality, NL is an adherent of the reality theory.92 This theory describes the corporate entity as the expression of a no less actual entity than a natural person, the corporate entity is not a fictive person. In the reality theory the corporate entity is considered to be an actual entity, just as a natural person is. This is incorporated in the Dutch law system in art. 2:5 DCC, in which a legal person is equated with a natural person as regards the law of property, rights and interests, unless the contrary follows from the law. In this theory it is anchored that the Dutch law system is a reflection of the way of thinking, the attitude and actions that are part of social reality. The qualification of entities is therefore strongly related to the degree in which separate capital exists, forms a bound community, or is abstracted from natural persons and has a certain purpose.93 Only when an entity has subsequent substance, its income cannot be accounted directly to the participants, but to the entity itself and it can have corporate personality.94 Besides that, Dutch law is decisive in the qualification of entities. Therefore the theory of fiction also plays a role in the Dutch system for qualification of entities.95 Furthermore NL is an adherent of the incorporation principle, which means that an entity is ruled by the law of the state of establishment, if the entity has a seat there. The counterpart of the incorporation theory is the real seat principle, which means that an entity is subject to the law of the state where the entity has its centre of activities.96

3.2.1 Domestic entities Even though the DCC denominates entities, this law does not describe what corporate personality is.97 However, in determining corporate personality for domestic entities a number of factors are of

90 In references to, for example, article 1, paragraph 1 in the Dutch Civil Code, Book 2, hereafter: art. 2:1 (1) DCC. 91 This follows from art. 2:1, paragraph 2 DCC. 92 M.J.G.C. Raaijmakers, Pitlo Deel 2 Het Nederlands burgerlijk recht, Vennootschaps- en rechtspersonenrecht, Deventer: Gouda Quint 2000, p. 38. 93 J.H. Nieuwenhuis, Uit de ban van hier en nu (inaugurel lecture), Tilburg 1980. 94 By the Dutch Supreme Court in Hoge Raad 31 December 1924, B. 3570 and Hoge Raad 7 June 1939 B. 6925 the independent authorization to account profit to the entity is decided as the basis of corporate personality. 95 E.A. Brood, Fiscale Monografieën 48, De vestigingsplaats van vennootschappen, Deventer: Kluwer 1989, p. 7. 96 L.F.A. Steffens, Strijd tussen de incorporatieleer en de leer van de werkelijke zetel, De vrijheid van vestiging in Europa volgens het Hof van Justitie, TvOB 2004/1. NL has created a law to counterbalance abuse of the incorporation principle in 1998 (Wet Formeel Buitenlandse Vennootschappen), which prescribes certain requirements to formal foreign entities but does not overrule or replace the law of the state of establishment. See also G.K. Fibbe, EC Law Aspects of Hybrid Entities, Amsterdam, IFBD 2009, p. 22-24. 97 M.J.G.C. Raaijmakers, 2000, p. 5, 38 and 208.

3. Corporate versus non-corporate entities importance, namely the purpose, representation, authority and liability of the entity.98 An entrepreneur-to-be has to consider whether the company is conducted with profit motive and the scale of its activities to determine the purpose of the business. This purpose has to be incorporated in the articles of association of the corporation. Thought should also be put into the representation of the corporation. There can be a board of directors and separate shareholders or there can just be one or a few large shareholders who are also directors. The design of authority is important, for instance it can be equally divided over all shares or a combination of shares without authority and voting shares. The design of the authority of a legal form is either recorded in its articles of association or legally determined by law. The form of liability should also be taken into account when „choosing‟ a legal form. These factors are thus to some extent bound to the legal form that is chosen by an entrepreneur. Above this, the future aspect of the business should be kept in mind, because switching legal forms might include large consequences, both in the fiscal area as in other significant areas. All of these factors can be combined as the material aspects of corporate personality. The civil indication of an entity is the formal aspect of corporate personality.99

The DCC specifies the different private entities in further articles, mostly based on these factors. Associations ex art. 2:26 DCC are constituted with a specific object by a multilateral legal act and may not distribute profits among its members. A cooperative ex art. 2:53 (1) DCC is an association established by notarial deed to provide for certain material needs of its members under agreements concluded with them in the business it conducts or causes to be conducted to that end for the benefit of its members. A mutual insurance society ex art. 2:53 (2) DCC is an association established by notarial deed to conclude insurance contracts with its members, each in the insurance business it conducts to that end for the benefit of its members. A company limited by shares ex art. 2:64 DCC is a legal person with an authorised capital divided into transferable shares, incorporated by notarial deed with a certificate from the Minister of Justice of no objections. A private company with limited liability ex art. 2:175 DCC is a legal person with an authorised capital divided into not freely transferable shares, incorporated by notarial deed with a certificate from the Minister of Justice of no objections.100 A foundation ex art. 2:285 DCC is a legal person created by a legal act without members to realise an object stated in its articles. Art. 2:286 DCC states that a foundation must be established by notarial deed.

98 M.J.G.C. Raaijmakers, 2000, Chapter 3, p. 204-223. The Chamber of Commerce provides advice on this matter for new entrepreneurs, see www.kvk.nl. 99 W.J. Slagter, Compendium Ondernemingsrecht, Deventer: Kluwer 1996, p. 37. 100 The upcoming amendment of law regarding the simplification and the making flexible of this legal form, Kamerstukken II, 2006-2007, 31 058, Wet vereenvoudiging en flexibilisering bv-recht, will not change the matter of corporate personality for this legal form. The amendment of law sees to the creating of a more competitive legal form in international perspective and the clarification of certain issues and uncertainties in the existing law on private companies with limited liability.

3. Corporate versus non-corporate entities

Entities without legal personality are one-man businesses and transparent partnerships. Liability is vested with the persons behind these companies. Non-corporate entities are simply all entities that are not qualified by law as entities with corporate personality.

European legislation on legal forms also exists. Three European legal forms can be named, the European Economic Interest Grouping (EEIG), the European Company (Societas Europaea, SE) and the European Cooperative Society (Societas Cooperativa Europaea, SCE).101 The Regulation on EEIG‟s states in art. 1 (3) that Member States decide whether EEIG‟s are corporate or non-corporate entities.102 Accordingly, NL has determined that an EEIG that is founded in NL possesses corporate personality, art. 3:114 (1) DCC. For tax on profits the EEIG is considered transparent, so that the participants are liable to tax for the profit of the EEIG.103 The EEIG can enter into binding agreements in the economic traffic, but the participants are liable for these agreements just like they are with non- corporate entities. In the Regulation on SE‟s it is qualified as a corporate entity in art. 1 (3). This is incorporated in the DCC in Book 115. The SCE also has corporate personality ex art. 1 (5) Regulation on SCE‟s, which is incorporated in the DCC in Book 118. These legal forms are in principle the starting point for supranational cooperation of entities, which will of course contribute to the completion of the intended internal market of the EU.104

3.2.2 Choice? As described above, the DCC determines corporate personality for entities. Entrepreneurs have an effect on the different factors that are relevant in NL for the determination of corporate personality, as long as they still have to choose the legal form in which their business will be conducted.105

An amendment of law is about to be introduced regarding partnerships.106 By this amendment it becomes possible for certain forms of partnerships, under certain conditions, to opt for corporate personality. In the legal qualification of partnerships, the possession of corporate personality is relevant for who, the entity or the participants, enjoys business results and thereafter the degree to which the participations are freely transferable.107 By current law all different forms of partnerships, with one exception, don‟t posses corporate personality. The transparent partnerships or non-corporate entities are called ‘maatschap’ and ‘vennootschap onder firma (VOF)’. With respect to the third form of partnerships, ‘commanditaire

101 See respectively Council Regulation (EEC) No 2137/85 (EEIG), Council Regulation (EEC) No 2157/2001 (SE) and Council Regulation (EC) No 1435/2003 (SCE). 102 This Regulation is incorporated in the DCC in Book 113. 103 S.A. Stevens, Fed fiscale brochures, VPB, Belastingplicht in de vennootschapsbelasting, Deventer: Kluwer, 2009, p. 63 and M.L.M. van Kempen, 1999, p. 2. 104 Art. 3 paragraph 2 and 3 Treaty TFEU. 105 Goossen refers to this as a certain amount of freedom of choice in joining civil criteria regarding a legal form. See H.P.J. Goossen, Fed fiscale brochures, VPB, Belastingplicht in de vennootschapsbelasting, Amsterdam: FED 1991, p. 19. 106 Kamerstukken II, 2003-2003, 28 746, nr. 6. The date of commencement is unknown due to a number of postponements of institution of this law. 107 S.A. Stevens, 2009, p. 7, 8 and M.L.M. van Kempen, 1999, p. 69-70 and p. 133-123.

3. Corporate versus non-corporate entities vennootschap (CV)’, a distinction can be made between open and closed CV‟s.108 Open CV‟s have legal personality and closed CV‟s don‟t. In the new law system the old forms of partnerships are replaced by three forms of partnerships, of which two can chose (not) to have corporate personality. The ‘maatschap’ is replaced by the ‘stille vennootschap’, this is a partnership in which the partners don‟t come forward under a joint name, that continues to have no corporate personality. The VOF and the CV are replaced by respectively the ‘openbare vennootschap (OV)’ and the ‘commanditaire vennootschap (CV)’.109 Both of these business enterprises can choose to have corporate personality (rechtspersoonlijkheid (R)).110 With corporate personality they become OVR and CVR and the entity itself posses legal and economic ownership of the capital. This corporate personality is instituted by a notarial deed and doesn‟t influence the liability of the partners. The liability stays dependent on the classification of (non-)transparency. This is more or less the same as with EEIG‟s.111 The OVR and CVR can enter into binding agreements as a judicial entity, while in an OV and CV only the partners can do this.

Overall it can be concluded that a certain level of choice regarding the legal form of a business exists, based on the above described factors that individuals can influence, namely purpose, representation, authority and liability of an entity. It is however determined in the DCC whether an entity possesses corporate personality. In the future it is likely that there will be two forms of partnerships which can decide for themselves whether they opt for corporate personality, namely the OV(R) and CV(R).

3.2.3 Foreign entities In general all states classify entities autonomously, tax classification in the other state is not taken into account. This might lead to double (non-)taxation. As already described, a state can follow either the incorporation principle or the real seat principle for determining residency of entities, based on respectively the place in which an entity is established and the place from which an entity is actually managed. NL is an adherent of the incorporation principle112, even though a lot of EC Member States follow the real seat principle.113 Both principles might interfere if an entity is qualified by one state as a domestic entity based on the incorporation principle, while that same entity is also qualified as a domestic entity by the other state based on the real seat principle. Even though bilateral tax treaties

108 The open CV is qualified as non-transparent and the closed CV is qualified as transparent. An open CV exists if entry or replacement of silent partners can take place without authorization of all partners, both managing and silent partners. See Decree of 11 January 2007, nr. CPP2006/1869M. 109 M.L.M. van Kempen and A.W.G. Lamers, Het wetsvoorstel personenvennootschappen en de gevolgen voor de inkomstenbelasting en de vennootschapsbelasting, TFO 2008/1. 110 M.L.M. van Kempen, Het wetsvoorstel Titel 7.13 BW en de fiscale transparantie van personenvennootschappen, WFR 2003/285 and M.L.M. van Kempen and A.W.G. Lamers, Het wetsvoorstel personenvennootschappen en de gevolgen voor de inkomstenbelasting en de vennootschapsbelasting, TFO 2008/1. 111 A.J.A. Stevens, Wetsvoorstel Invoeringswet titel 7.13 BW: enige vennootschapsbelastingaspecten, WFR 2007/819. 112 Art. 2 Dutch Conflicts Law Act (Wet conflictenrecht corporaties van 17 december 1997). 113 L.F.A. Steffens, Strijd tussen de incorporatieleer en de leer van de werkelijke zetel, De vrijheid van vestiging in Europa volgens het Hof van Justitie, TvOB 2004/1.

3. Corporate versus non-corporate entities might solve this issue114, for now will be elaborated how NL handles the qualification of foreign entities.

In NL a decision regarding the qualification of foreign entities is made on the basis of four different criteria. These criteria are whether the entity can posses ownership, the liability of associates, whether the entity has a capital divided into shares and whether the participations are freely transferable.115 In the judgement whether an entity is to be qualified as (non-)corporate, the foreign civil law serves as the bases of the decision. The foreign civil law is firstly used to determine the legal position of the entity and the participants. Then a decision whether this entity with these civil features has corporate personality by Dutch measures, is made according to Dutch fiscal criteria.116 An example of this procedure can be found in HR BNB 2006/288c.117 In this decision a US limited liability company (LLC) was held by a Dutch parent company by 20% of the shares. The LLC was a hybrid entity, since it had marks of both a corporate and a non-corporate entity. Therefore the civil features of the LLC were to be judged and then compared to whether the LLC would have corporate personality by Dutch standards. Facts were that the LLC was non-transparent, since the participants were only liable for their own deposit, the enterprise was owned by the LLC and the enterprise was not conducted for risk and expense of the participants. Furthermore the LLC was qualified as an entity with a capital divided into shares. These facts led to the conclusion that the LLC was qualified as a non-transparent corporate entity for Dutch tax purposes.

First it is judged regarding all cooperations on the basis of foreign civil law, the articles of association or the agreement of the cooperation and Dutch law, whether an entity is an entity with capital divided into shares or a partnership. If a company is qualified by foreign civil law as an entity with capital divided into shares, ownership is at the level of the entity and all participants have limited liability, it is non-transparent and results are allocated to the entity. If a company is qualified as a partnership, it is transparent and results are allocated to the participants. Hybrid entities are qualified as transparent or non-transparent on the basis of the four above mentioned criteria. The criteria for qualification of foreign entities are used as follows:  If an entity can posses ownership and the liability of the participants doesn‟t go beyond the deposited capital, it is qualified as a non-transparent or corporate entity.118

114 In G.K. Fibbe, 2009, p. 133, is described that even though tax treaties might eliminate or mitigate certain double taxation as a result of classification conflicts, this is still an impediment compared to the situation for taxpayers who stay within one state. Furthermore the EU has made some efforts to alleviate international double taxation issues by determining in the Parent-Subsidiary Directive (90/435/EEG) that Member States must refrain from taxing profits distributed by a hybrid subsidiary. 115 Decree of 11 December 2009, nr. CPP2009/519M. This Decision excludes the qualification of the following forms of cooperations, which can be submitted to the Dutch Internal Revenue Service for judgment: cooperatives, associations with cooperative foundation, mutual insurance societies and associations which act by mutual foundation as insurer or credit institution. Note that this is a Decree, which can be relied upon by the taxpayer on the basis of the principle of trust. It is not a law. 116 H.P.J. Goossen, 1991, p. 65 and S.A. Stevens, 2009, p. 9. 117 Hoge Raad 2 June 2006, nr. 40919, BNB 2006/288c with conclusion from Advocate General Wattel. 118 Hoge Raad 2 June 2006, nr. 40919, BNB 2006/288c, adds to this that the entity may not be conducted for account of the participants.

3. Corporate versus non-corporate entities

 If three of the four above mentioned criteria can be answered affirmative, an entity is qualified as a non-transparent or corporate entity. If an entity cannot be qualified as an entity with capital divided into shares, it is in principle a partnership, and thus transparent. However, not all partnerships are considered transparent, based on their participation in economic traffic as if it is an entity with capital divided into shares. Judgement in this matter takes place as follows:  If an entity shows great resemblance to the Dutch CV119, only the fourth criterion needs to be judged. If the participations are freely transferable, the partnership is qualified as a non- transparent or corporate entity. If not, the partnership is qualified as a transparent or non- corporate entity.  If the liability of one or more of the participants goes beyond the deposited capital, the third and fourth criterion should be judged in order to decide on corporate personality120: o If an entity has a capital divided into shares and the participations are freely transferable, the entity is qualified as a non-transparent or corporate entity. o If an entity either doesn‟t have a capital divided into shares or doesn‟t have freely transferable participations, the entity is qualified as a transparent or non-corporate entity.

Due to these qualification criteria a lot of entities will be qualified the same as either corporate or non-corporate under both Dutch and foreign law. A certain overlap of qualification criteria for domestic and foreign entities exists. Criteria for domestic entities are purpose, representation, authority and liability of the entity, whereas for foreign entities they are whether the entity can posses ownership, the liability, whether the entity has a capital divided into shares and whether the participations are freely transferable. Differences between qualification in some cases, especially with hybrid entities, will exist. Even though the basis of the qualification for foreign entities is the foreign civil law, Dutch domestic law doesn‟t accept the qualification in foreign law for purposes of domestic law as far as the qualification in foreign law doesn‟t match the desired criteria for domestic law. Furthermore it can also be the case that the same criteria for qualification are used by both countries, but the interpretation of these criteria differ from each other which can lead to different qualifications. The Decree of 11 December 2009 refers to an extensive list of foreign entities with the accompanying qualifications on the website of the Dutch Internal Revenue Service. If an entity is not recorded on the list or foreign law has changed since it was recorded on the list, its qualification is judged at request by a knowledge group of the Internal Revenue Service and added to the list.121 The

119 An entity shows resemblance to a Dutch CV if has one of the following features: in the name of the entity an enterprise is conducted, there is at least one managing partner and one silent partner, the managing partner has unlimited liability or liable for an equal share to third parties, the silent partner is only liable for his deposited capital, the silent partner doesn‟t exercise external deeds of management and control and the entity doesn‟t have a capital divided into shares. These criteria are stated by the State Secretary in the Decree of 11 December 2009, nr. CPP2009/519M. 120 Judgment should take place on the basis of the decision of the Dutch Supreme Court, Hoge Raad 24 November 1976, nr. 17998, BNB 1987/13. 121 The list is indicative, it does not guarantee advanced certainty. See www.belastingdienst.nl/download/2440.html.

3. Corporate versus non-corporate entities above described criteria are crucial for determining the qualification of foreign entities, but the foreign qualification only plays a role for judging these criteria. Qualification under foreign law is not accepted just like that.

3.3 Double (non-)taxation due to different qualifications

To assess which country can and may levy tax in cross-border situations, three questions can be followed. Firstly is to be judged whether NL can levy taxes according to domestic law. Secondly is to be judged, regardless of the previous outcome, whether NL may levy taxes on the basis of a double tax treaty. If there is no treaty, the Dutch taxpayer can fall back on the Dutch unilateral decree for prevention of double taxation: Unilateral decree on the prevention of double taxation 2001 (Besluit voorkoming dubbele belasting 2001). The last check is whether NL may levy taxes on the basis of existing European law. For a clear explanation of when a situation of double (non-)taxation can rise, the above testing criteria can be divided into three short questions: 1. Can NL levy tax on the basis of domestic law? 2. May NL levy tax on the basis of a treaty (A) or a unilateral decree (B)? 3. May NL levy tax on the basis of EC-law? In the process of answering these questions, double (non-)taxation can emerge in a number of situations. All of these double (non-)taxation issues can originate even without the existence of different qualification of entities. The first opening for possible double non-taxation rises if the right to tax is allocated to NL in the treaty (A), but NL cannot levy taxes on the basis of domestic law. The other country has given away its right to tax, but NL cannot effectuate its right to tax. Neither of the countries levy tax in this case. If there is no double tax treaty, the Dutch taxpayer falls back on the unilateral decree of NL (B). If the right to tax is assigned to NL by this treaty and NL can also levy actual tax on the basis of domestic law, it is also possible that the other country levies tax on the same object on the basis of their domestic law. A unilateral decree cannot take foreign law into account, that is what a double tax treaty does. Double taxation therefore is a possibility. If NL does not have the right to tax on the basis of domestic law, but does have the right to tax on the basis of a treaty (A) and also on the basis of European law, double non-taxation can arise if the other country does not levy tax as a consequence of the working of the treaties in combination with the impossibility of NL to effectuate its right to tax. And finally it might be possible that NL can and may levy tax on the basis of domestic law and an existing treaty (A), but may not levy tax on the basis of European law. The right to tax is allocated to the other country on the basis of European law. This situation can be divided into a situation in which two Member States are involved and a situation in which NL and a third country are involved.

3. Corporate versus non-corporate entities

In the situation with two Member States, European law outranks national law. Double tax treaties should be made up and executed with the principles of European law implied in it. If this is however not the case, the treaties outrank European law, at least for NL. Treaty override is not legit in NL. So, assuming that most treaties are in line with European law, double taxation or double non-taxation in this situation in unlikely to occur. It is however possible that in some cases, treaty override in the other State and the imposition of taxes by NL according to the tax treaty instead of European law, might lead to double taxation or double non-taxation.122 In the situation with third countries, double taxation or double non-taxation is entailed not to arise, since in tax treaties between one Member State and a third party, agreements about taxing rights, based on national law systems, have been made between these two countries. Assuming NL has taken European perspective into account in this process, double (non-)taxation is hardly possible. In addition to this, NL is obligated to take the rules of the tax treaty into account before European law if they contradict. Double (non-)taxation however seems very unlikely in this situation.

In the judgment of taxation matters, access to the law at issue is the base of how to cope with qualification issues. A taxpayer is only obliged to pay tax if it falls inside the scope of a law or a treaty. Qualification as either domestic or foreign taxpayer is important to judge how a certain taxpayer is taxed under domestic law. In NL this is recorded in the Dutch Corporate Income Tax Act 1969 (Wet op de vennootschapsbelasting 1969, CITA). CITA is divided into domestic and foreign tax liability. The qualification of an entity as domestic and foreign can be based on the exhausted account of tax subjects in art. 2 and 3 CITA.123 At this stage the qualification of the entity in the other country is not yet relevant. If an entity is qualified as a domestic taxpayer, NL levies tax on its worldwide income. If it is qualified as a foreign taxpayer, NL levies tax on its Dutch income. For cross-border income situations the treaty is leading.124 An entity has access to the OECD-MC if it is qualified liable to tax as a resident of one or both of the countries in question on the basis of art. 4 (1) OECD-MC. This liability to tax is a subjective subordination, the objective or actual subordination is irrelevant for judging liability to tax.125 In the Commentary on art. 4 OECD-MC, paragraph 8.5, this is worded as follows: „In many countries, a person is considered liable to comprehensive taxation even if the Contracting State does not in fact impose tax‟.126 If a person other than an individual is a resident of both States, the place of effective management is determinative for

122 In Austria for example treaty override is allowed. 123 H.P.J. Goossen, 1991, p. 9. 124 Since the specification of all different treaties the Netherlands has is too broad to discuss here, the OECD-MC serves as the basis for how qualification in treaties works. 125 NL follows this explanation of a resident, full liability to tax is qualifying for residence. See A.C.G.A.C. de Graaf and F.P.G. Pötgens, Verontrustende Hoge Raaduitleg verdragsbegrip ‘inwoner’, WFR 2010/266 and Hoge Raad 28 February 2001, nr. 35557, BNB 2001/295, (Drielandenpunt). The actual imposition of tax is not determinative in the qualification of residence, also confirmed in Hoge Raad 16 January 2009, nr. 43128, BNB 2009/93 and Hoge Raad 16 January 2009, nr. 42218, BNB 2009/92. 126 See also E.A. Brood, 1989, p. 256.

3. Corporate versus non-corporate entities its residency ex art. 4 (3) OECD-MC.127 The treaty outranks national law and therefore these last qualification rules are determinative. In the general definitions in art. 3 OECD-MC it is stated that the qualification of a company or national as a legal person, partnership or association follows the status it has in national law. Thus, at first national law is relevant to determine the status of an entity, but if this leads to a dual residence, the provision in art. 4 (3) OECD-MC becomes binding. Different qualification for entities with a dual residence are taken away by this provision and the mentioned ranking order. This is however not the case if an entity is differently qualified by states and this qualification does not lead to a dual residence. For instance if NL qualifies the entity as corporate while the other state qualifies the entity as transparent. This will mostly occur with respect to hybrid entities. This topic is more extensively discussed in the following paragraph concerning the principle of equality in relation to tax treaties. Furthermore if there is no treaty, the unilateral decree for the prevention of double taxation of NL becomes significant for Dutch residents. This tax act follows domestic law for qualification of entities. Different qualification of an entity compared to the other state is a possibility then. Unfortunately, this cannot be taken away by any domestic law or (the missing) double tax treaty, so double (non-)taxation can emerge in this situation.

So as far as double tax treaties exist, agreements have been made about qualification issues regarding dual residence and therefore double (non-)taxation is taken away by these agreements in situations with a dual residence. If different qualification does not result in dual residence, this is not solved by the treaty. If there is no treaty and the unilateral decree on the prevention of double taxation of NL is applicable, different qualification of entities under domestic and foreign law is possible. The double taxation or non-taxation that subsequently arises, cannot be taken away. For residents NL grants a tax relief for their foreign income, but this is automatically not the case for non-residents. So if the foreign country does not grant a tax relief for the Dutch income of the non-resident, double taxation remains. Due to the lack of the right to tax by either one of the countries on the basis of their domestic law in certain situations, double non-taxation will remain for both residents and non- residents.

3.4 Evaluation: equality and different qualifications

The principle of equality as described in the previous chapter, will be held against the described qualification of entities. In the assessment on matters of the principle of equality, the circumstances for both cases in question are compared. Equal treatment may be required if this is related to the

127 E.A. Brood, 1989, p. 243 et seq.

3. Corporate versus non-corporate entities purpose of a certain measure or requirement and if no objective distinctions may be made in the situation under consideration. It is possible to treat equal situations unequally if there is an objective and reasonable justification for unequal treatment. Unequal cases shall be treated unequal proportionate to their inequality. Next will be evaluated what the impact of the principle of equality is in constitutional law, European law, WTO law and tax treaties in the light of different qualifications of an entity.

3.4.1 Constitutional law NL distinguishes between domestic and foreign entities in the criteria that are used for the qualification of entities. The principle of equality in the Constitution refers to equal treatment for „all persons in the Netherlands‟, which sees to both domestic as to foreign entities that generate Dutch income. Since the criteria that determine corporate personality are the same for all domestic situations, as they are the same for all foreign entities, there is no discrimination in purely domestic or purely foreign situations. Between domestic and foreign situations there is however a distinction. It is debatable whether a distinction between these situations should be made. In general can be said that states qualify domestic and foreign entities differently. Therefore I hold the inequality between domestic and foreign qualification justified. This does not expand to the method of qualification.

3.4.2 European law NL qualifies domestic and foreign entities as corporate or non-corporate in a different way. For the qualification of foreign entities it is explained that NL uses the foreign civil law as a basis to determine the legal position of the entity and the participants, but a decision on the matter is made based on Dutch fiscal criteria. In European perspective the ECJ has accepted in case law that a state is allowed to take into consideration the differences in the legal framework of its own and of the foreign state, hence the Dutch method is an appropriate classification method.128 This system might however lead to classification differences in states for the same entity and consequently possibly to double taxation or double non-taxation. The concept of mutual recognition, that has been introduced in the 1970s, can be a force of solution in this situation.129 The concept was that in order to avoid impediments to the free movement in the internal market, Member States were to mutually recognize each other‟s legislation. A legal basis for this has yet to be established. Even though this could be a good concept to avoid issues in the area of double (non-)taxation, the scope of this principle is limited to the treaty freedoms since it does not see to fiscal disparities and discrimination on the basis of nationality hardly ever is the cause of double taxation or double non-taxation.130 Also the different approaches from countries in determining residency of entities, either by the incorporation principle or the real seat principle, might lead to an impediment. This leads further to

128 G.K. Fibbe, 2009, p. 98-100. 129 G.K. Fibbe, 2009, p. 47-50. Mutual recognition seemed to be more easily achievable at that time than integration through harmonization. 130 G.K. Fibbe, 2009, p. 93, 103 and 148-152. This is due to the fact that fiscal disparities cannot be erased by the TFEU and different classifications are mostly not the consequence of discrimination on the basis of nationality.

3. Corporate versus non-corporate entities the decision of the ECJ in Columbus Container Services131 that a Member State may choose not to make a distinction between the taxation of income derived from profits of partnerships established in another Member State and taxation of income derived from profits of partnerships established in the Member State itself. Furthermore the ECJ ruled that fiscal autonomy means that Member States are autonomous to classify foreign entities for domestic tax purposes, as long as they are not treated discriminatory in comparison with national entities.132 Member States do, due to this autonomy, not have to adapt their legislation to that of other Member States in order to accomplish similar taxation for entities in either Member State.133 This decreases the obligation for Member States to use a uniform method for classification of foreign entities, certain specific provisions in directives taken into account.134 Therefore, even though in European perspective these differences within the light of the internal market should be resolved, Member States are very free to determine the classification for foreign entities themselves.

3.4.3 WTO law NL does not make distinctions in the qualification of foreign entities between countries, all foreign entities are qualified by the same system. This approach is in line with the most-favourable nation treatment rule. NL does not qualify domestic and foreign entities as corporate or non-corporate in the same way. This different treatment could possibly be linked to the national treatment rule if NL has committed itself to national treatment in that respect.135 Since national treatment for NL is not required to services other than financial services, this measure of non-discrimination is not applicable to the distinctions in the legal qualification of entities for domestic and foreign entities. So the different qualification of domestic and foreign entities in NL could be out of line with the non-discrimination principle in WTO law, more specifically the national treatment rule. There however is no commitment from NL to equal treatment of services in that respect and therefore the distinction between domestic and foreign situations seems justified.

3.4.4 Tax treaties (OECD-MC) In the Commentary on art. 24 OECD-MC, paragraph 1, nr. 17, can explicitly be found that „the different treatment of residents and non-residents is a crucial feature of domestic tax systems and of tax treaties‟. Furthermore in the Commentary can be found that the article deals with the elimination of tax discrimination in precise circumstances, that is when all factors are equal and the different treatment is solely based on the difference that is prohibited by a provision. The distinction NL makes between the qualification of domestic and foreign entities is that for domestic entities purpose,

131 ECJ 6 December 2007, C-298/05 (Columbus Container Services). 132 See also G.K. Fibbe, 2009, p. 170-173. 133 ECJ 6 December 2007, C-298/05 (Columbus Container Services), point 51. 134 See list of entities in Parent-Subsidiary Directive, art. 2 and appendix (90/435/EEG). 135 Schedule of Specific Commitments, Supplement 4, revision, 18 November 1999, GATS/SC/31/Suppl.4/Rev.1, this document shows that the EU (and therefore NL) has only committed itself with respect to the financial service sector.

3. Corporate versus non-corporate entities representation, authority and liability of the entity are relevant whereas for foreign entities it is relevant whether the entity can posses ownership, the liability, whether the entity has a capital divided into shares and whether the participations are freely transferable. The basis for qualification of foreign entities is the foreign civil law. Characteristics of a hybrid entity are judged to determine the legal position of the entity and the participants. Then a decision whether this entity with these civil features has corporate personality by Dutch measures, is made according to Dutch fiscal criteria. If a certain term is not defined in the OECD-MC, for interpretation of the term is referred to the laws of the contracting states on the basis of art. 3 (2) OECD-MC. Both states might interpret a term differently, which might lead to classification conflicts between states and consequently to double (non-)taxation. The solution that is provided in the OECD Commentary is that in case of a different classification of an entity, the source state should take into account the way in which the income of the entity in the source state is treated by the resident state of the entity on the basis of the treaty.136 Different qualification of entities is thus solved in the OECD-MC. Since the resident state of the entity shall levy taxes upon the worldwide income of the entity, the OECD-MC further recommends the resident entity to take into account the objective qualification of the income of the entity by the source state. By this twofold solution that sees to the subjective and objective qualification, equal treaty access from perspective of both concerning states will be established as well as equal qualification of the relevant income. This ensures application of the same articles in the treaty by both states. Even though this is a nice solution in the light of the principle of equality, it unfortunately cannot be enforced before court.

3.5 Taxation of entities

3.5.1 Entities subject to CITA CITA is divided into both domestic and foreign tax liability. This tax liability is recorded in detail respectively in art. 2 and 3 CITA. Resident entities that are liable to tax in NL for their worldwide income are exhaustively: Naamloze Vennootschappen137, Besloten Vennootschappen138, Open Commanditaire Vennootschappen, other entities with capital (partly) divided into shares, verenigingen and coöperaties, onderlinge waarborgmaatschappijen and stichtingen.139 Non-resident entities that are liable to Dutch tax if and insofar they generate Dutch income, are exhaustively:

136 G.K. Fibbe, 2009, p. 211-212 and 225-226, the Commentary on art. 1, par. 5 and 6.3 OECD-MC and the Commentary on art. 4, par. 8.4 OECD-MC. This concept was first introduced in OECD, The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999. 137 This entity is comparable to for example the Public Limited Partnership (PLP) in the United Kingdom, the Aktiengesellschaft (AG) in Germany and the Société Anonyme (SA) in France. 138 This entity is comparable to for example the Limited Liability Partnership (LLP) in the United Kingdom. 139 Direct public enterprises are also included in corporate income tax as far as the exhaustive list of art. 2 paragraph 3 CITA indicates. This is however only the case if and insofar they compete with private enterprises. Indirect public enterprises are included in corporate income tax on the basis of art. 2 paragraph 7 CITA, but only if and insofar they carry on a business. Exceptions to this are named in the articles. In this paper this form of entities will not be treated. For more information see J.N. Bouwman, Wegwijs in de Vennootschapsbelasting, Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2007, p. 59-63.

3. Corporate versus non-corporate entities verenigingen and other corporate entities, Open Commanditaire Vennootschappen and other non- corporate entities with capital (partly) divided into shares and doelvermogens. In the Dutch tax liability is included, by article 17 (3) (a) CITA, the income received through a permanent establishment (PE) situated in NL, held by a foreign entity.

Resident entities are liable to tax with their entire capital based on art. 2 (5) in conjunction with art. 7 CITA.140 NL levies tax on their worldwide income and gives a tax relief for their foreign income. The subjective unlimited tax liability is recorded in art. 2 CITA and the objective unlimited tax liability is recorded in art. 7 CITA. Non-resident entities are liable to tax if and insofar they generate specific Dutch income based on art. 3 in conjunction with art. 17 CITA. Resident and non-resident entities that are subject to CITA broadly match. Domestic entities that are subject to CITA are described in more detail in the law and therefore seem to include more forms of entities than forms of foreign entities that are subject to CITA. The foreign entities in art. 3 CITA are described in a more open way, so that case law and social developments have an influence on the interpretation of this article.

In general resident entities are subject to corporate income tax if and insofar they carry on an enterprise.141 For certain legal forms the entity is considered to carry on the enterprise with the entire capital of the entity on the basis of art. 2 (5) CITA. In CITA however a number of subjective exemptions for entities exist on the basis of art. 2 (7) and art. 5 CITA. The definition of an undertaking is based on developments in case law and can be described as follows: „An undertaking is a permanent organization of capital and labor aimed at participation in the economic traffic with the intention to obtain profits. A certain continuation of the company is herein expected.‟142

Different criteria exist for resident and non-resident entities for subjection to CITA. For resident entities the criterion is that they are established in NL, art. 2 (1) CITA. It can also be sufficient to be regarded as a resident entity to be founded in NL, this is based on the principle of incorporation, see art. 2 (4) CITA.143 This is called the deemed place of establishment. Due to the incorporation principle it is possible that an entity is established in NL, but has its actual residence in another country.144 A treaty then can possibly resolve this double classification issue.

140 In NL a distinction can be made between private and business capital. Some entities contain both forms of capital, for example a one-man business carried on from the house where the entrepreneur also lives. If the house is held by the enterprise, the part that the entrepreneur lives in should be qualified as private capital. Therefore business capital is the entire capital that is used to carry on the enterprise. 141 Art. 2 in conjunction with art. 4 CITA. 142 N.H. de Vries and R.J. de Vries, Cursus Belastingrecht, Vennootschapsbelasting, Kluwer: Deventer 2008, section 1.0.4. 143 The effect and correctness in international situations of this provisions has been extensively discussed in literature, see amongst others B.J. Kiekebeld and J.A.R. van Eijsden, Fed fiscale brochure, Div., Nederlands belastingrecht in Europees perspectief, Kluwer: Deventer 2009, p. 105-107. 144 L.F.A Steffens, Strijd tussen de incorporatieleer en de leer van de werkelijke zetel, De vrijheid van vestiging in Europa volgens het Hof van Justitie, TvOB 2004/1.

3. Corporate versus non-corporate entities

Residence of an entity is in Dutch tax law judged by the actual circumstances.145 In this matter the decisive factor is the place of effective management. A number of sub criteria have been developed in case law to specify this. These are the place where the board of managing directors meets and where important decisions are made, the residence of the managing directors, the place where its main office is located, the place where the consolidated bookkeeping is kept and the financial instruments are prepared, the country in which the company is liable to tax, the country of the statutory seat, the country where the company is incorporated, the place where the (main) bank account is maintained, the place where shareholders meetings are held, the place where the enterprise of the company is carried on and the place where the assets of the company are located.146 Non-resident entities are subject to CITA if and insofar they generate Dutch income. The Dutch income is the taxable profit generated in NL by Dutch company activities or a PE of a foreign entity.

3.5.2 Taxation of (non-)corporate entities In the overview of the taxation of (non-)corporate entities and its shareholders, in addition to the explanation of tax liability in CITA, tax liability on the basis of the Dutch Personal Income Tax Act 2001 (Wet op de inkomstenbelasting 2001, hence: PITA) is briefly stated. For Dutch residents the unlimited tax liability is based on art. 2.1 in conjunction with art. 2.3 PITA. Limited tax liability for non-residents is recorded in art. 2.1 in conjunction with art. 7.1 PITA. Furthermore NL levies a withholding tax on dividend on the basis of the Dividend Tax Act 1965 (Wet op de Dividendbelasting 1965, DTA) upon shareholders of Dutch entities. More specific, a withholding tax on dividend is levied upon shareholders of in NL established NV’s (companies limited by shares), BV’s (private companies with limited liability), OCV’s (open limited partnership) and other entities with a capital wholly or partly divided into shares. The tax rate is on the basis of art. 5 DTA 15%.147 No withholding tax on dividend can be levied upon foreign entities on the basis of Dutch tax law. It is elaborated how natural persons as shareholders, both resident and non-resident, are taxed if they hold shares (< 5% or  5%) respectively in a Dutch entity and a transparent Dutch entity. Secondly is discussed how holding entities, both resident and non-resident, are taxed if they hold shares (< 5% or  5%) in subsequently a Dutch entity and a transparent Dutch entity. In all cases is explained how profits generated by the entity are taxed in either CITA or PITA.

In this situation the Dutch entity is taxed on the basis of art. 2 in conjunction with art. 7 CITA with a tax rate of 20% up till 25,5%. Profit distributions of the entity are

145 Article 4 paragraph 1 General law on taxation (Algemene wet inzake rijksbelastingen). 146 See (amongst others) Hoge Raad 23 september 1992, BNB 1993/193, Hoge Raad 1 juli 1987, BNB 1987/306, Hoge Raad 30 november 1988, BNB 1989/87 and Hoge Raad 1 juli 1987, BNB 1987/306. 147 From this tariff is deviated, in favour of the taxpayer, in various double tax treaties.

3. Corporate versus non-corporate entities taxed with a withholding tax on dividend on the basis of art. 1 DTA. In case the shareholder is a Dutch resident, it is subject to PITA for the profit distributions either on the basis of art. 2.1 in conjunction with art. 4.1 PITA if it holds 5% or more of the shares of the entity or on the basis of art. 2.1 in conjunction with art. 5.1 PITA if it holds less than 5% of the shares. Applicable tax rates are respectively 25% and 30% on an estimated yield of 4%, which leads to an effective tax rate of 1,2%. The withheld dividend tax can be offset to the personal income tax in both cases based on art. 9.2 PITA. If the shareholder is a non-resident, it is subject to PITA for the profit distributions of the Dutch entity either on the basis of art. 2.1 in conjunction with art. 7.5 PITA if it holds 5% or more of the shares of the entity or on the basis of art. 2.1 in conjunction with art. 7.7 PITA if it holds less than 5% of the shares. Applicable tax rates are the same as to resident shareholders. Withheld dividend tax can also be offset as a withholding tax for non-resident shareholders on the basis of art. 9.2 PITA.

In case the entity is qualified as transparent, results of the entity are allocated to the shareholders or participants, whom are subject to PITA on the basis of art. 2.1 in conjunction with ar. 3.1 PITA if they are residents. If the shareholders or participants are non-residents, they are subject to PITA on the basis of art. 2.1 in conjunction with art. 7.2 PITA. Tax rate is for both situations a progressive rate up till 52%. Since the entity is transparent, profit distributions are directly accounted to the income of the shareholders. No dividend tax is levied upon these profit distributions.

Profits of the Dutch entity are taxed on the basis of art. 2 in conjunction with art. 7 CITA with a tax rate of 20% up till 25,5%. Profit distributions of the entity are subject to dividend tax on the basis of art. 1 DTA with a rate of 15%. If the holding entity is a resident and holds less than 5% of the shares, the received dividends are included in the tax base of the shareholder, whose profit is taxed in CITA with a tax rate of 20% up till 25,5%. Dividend tax is a withholding tax and can be offset against the payable taxes on the basis of art. 25 CITA. If the entity however holds 5% or more of the shares of the Dutch entity and some other conditions are met, the participations exemption is applicable based on art. 13 CITA. Through this participations exemption the profit distributions received from the participations are excluded from the taxable profit of the holding entity. No dividend tax is levied upon such profit distributions on the basis of art. 4 (1) (a) DTA. In the situation that the holding entity is a non-resident and holds 5% or more of the shares of the Dutch entity, profit distributions are excluded from its tax base due to the participations exemption in art. 13 CITA in conjunction with art. 4 (1) (a) DTA. If the non-resident holding entity holds less than

3. Corporate versus non-corporate entities

5% of the shares, dividend tax is a withholding tax on the taxable profits of the entity, which are taxed at a rate of 20% up till 25,5% on the basis of artt. 3 and 17 in conjunction with art. 25 CITA.

The Dutch entity is qualified as transparent. Therefore the results are directly allocated to its shareholders. This implies that profit distributions of the transparent entity are included in the taxable profit of the holding entity. This profit is taxed at a rate of 20% up till 25,5% in CITA, regardless whether the holding entity is a resident or a non-resident.

This description of the Dutch system of taxation of corporate and non-corporate entities and their shareholders, does not alter the fact that in cross-border situations the right to tax a profit distribution can be allocated differently. Based on art. 10 OECD-MC the resident state of the distributing entity has the right to tax. The resident state of the shareholder has an additional right to tax the profit distribution, but this is bound to a maximum tariff.148

3.5.3 Overview The above described taxation of results of corporate and non-corporate entities, both resident and non-resident, is summarized in a table. In addition to that the taxation of profit distributions to shareholders is summarized in a table. Similarities and differences, specifically in the light of the principle of equality can be read from this overview. In the first table the taxation of profit distributions at the level of the shareholder can be read:

Domestic situation Dutch entity Dutch transparent entity Cross-border situation Shareholder: natural person < 5%  1,2% art. 2.1 icw 5.1 PITA* Results allocated to shareholders  < 5%  1,2% art. 2.1 icw 7.7 PITA* max. 52% art. 2.1 icw 3.1 PITA  5%  25% art. 2.1 icw 4.1 PITA* Results allocated to shareholders   5%  25% art. 2.1 icw 7.5 PITA* max. 52% art. 2.1 icw 7.2 PITA Shareholder: entity < 5%  20-25,5% art. 2 icw 7 CITA* Results allocated to shareholders  < 5%  20-25,5% art. 3 icw 7 CITA* 20-25,5% art. 2 icw 7 CITA  5%  0% art. 13 CITA Results allocated to shareholders   5%  0% art. 13 CITA 20-25,5% art. 3 icw 7 CITA * Dividend tax is a withholding tax on the basis of art. 9.2 PITA respectively art. 25 CITA

Taxation results of entity Resident Non-resident Corporate entity art. 2 icw 7 CITA  worldwide income art. 3 (b), (c) icw 17 CITA  Dutch income Non-corporate entity art. 2.1 icw 3.1 PITA  income partners art. 3 (a), (b) icw 17 CITA  Dutch income

3.6 Evaluation: equality and taxation of entities

To compare the qualification of entities to the subjection of entities to tax, this is summarized in the following table:

148 Art. 10 (2) OECD-MC states that the maximum tariff is 5% if the beneficial owner is a company (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends and that the maximum tariff is 15% in all other cases.

3. Corporate versus non-corporate entities

Criteria for corporate personality Criteria for subjection to tax Domestic entity: Purpose, representation, authority and Resident entity: Establishment in NL (deemed liability (DCC determines) place of establishment art. 2 (4) CITA) Foreign entity: Ownership, liability, capital divided into Non-resident entity: Generate specific Dutch shares and participations freely transferable income

In general it can be concluded that criteria for determining corporate personality and criteria for subjection don‟t match. First of all the criteria for determining corporate personality for domestic versus foreign entities only partly match. Similarities between these two are that liability and authority or ownership both play a role. The rest of the factors are not comparable. The same can be said for the criteria for subjection to tax. The applicable criteria for resident versus non-resident entities don‟t match. Comparing both sets of criteria for domestic and resident entities leads to the conclusion that these do not resemble at all. The same can be concluded for both sets of criteria for foreign and non- resident entities.

In the following part the principle of equality as described in the theoretical framework will be placed in relation to the taxation of entities. The taxation of entities will subsequently be evaluated in the light of the principle of equality in constitutional law, European law, WTO law and tax treaties.

3.6.1 Constitutional law The right to equal treatment in taxation on the basis of the Constitution is applicable to „all persons in the Netherlands‟. Different treatment of resident and non-resident taxpaying entities is based on establishment in NL. Residency and non-residency are the basis for taxability of respectively worldwide and Dutch income of an entity. In tax law this distinction between unlimited and limited tax liability for resident versus non-resident entities is generally excepted. The different treatment of resident corporate and resident non-corporate entities with shareholders or partners subject to either personal income tax or corporate income tax is relevant in constitutional law. This withholds two different treatments, firstly the different treatment of natural persons and entities as shareholders and secondly the different treatment of resident corporate versus resident non- corporate entities. Considering the first distinction can be said that for both categories taxpayers different tax laws are applicable in NL, namely personal income tax and in corporate income tax. It can be argued that natural persons and entities cannot be seen as equal, and therefore do not have to be treated equally. However, a natural person and an entity as shareholders are usually only bound to the capital of the entity to the extent of their deposit. In that respect a neutral taxation of both taxpayers as shareholders can be defended. Different taxation, in PITA and CITA, can then be an unjustified discrimination. The second distinction follows from the consequences the Dutch legislator attaches to the possession of corporate personality. NL levies tax on the worldwide income of a resident, whether the resident is an individual or an entity. If a corporate entity is the final receiver of the income, it is taxed

3. Corporate versus non-corporate entities on the basis of CITA. If a non-corporate entity receives the final income, the participants behind it are taxed on the basis of PITA due to the transparency of the entity. In both situations the intention of the legislator is to levy tax on the final receiver of the income. This is an equal treatment. The taxation in different tax laws however is a choice that the legislator has made. These different tax laws are opposed to an elaboration of a neutral income tax, so this might be a discrimination. So the practical results of taxation of corporate and non-corporate entities with shareholders subject to PITA or CITA somewhat differ. In conclusion can be said that it is debatable whether the principle of equality in constitutional law is taken into account sufficiently in taxation of corporate and non-corporate entities with shareholders subject to PITA or CITA, especially with respect to a neutral taxation for both subjects as shareholders. It has to be held in account that even though possibly an inequality might exist, due to the ban on judicial review it is up till now impossible to call upon the principle of equality in the Constitution.

3.6.2 European law European law concerns cross-border situations, therefore the distinction between corporate and non-corporate resident taxpayers is irrelevant in European tax law. The distinctions between non- resident taxpayers are based on the fact that these taxpayers are subject to different laws, corporate and personal income tax law. This distinction is closely linked to the degree of neutrality of both income tax laws. This is further elaborated in the following section, but in advance can be said that these laws are not equal in NL. However, even though in theory this distinction should not exist, in practice present European law, existing from the TFEU, case law from the ECJ, Directives and other measures relevant to taxes, is not suitable to eliminate this distinction. Regarding the distinction between resident and non-resident the same reasoning as within constitutional law can be followed. In European law the worldwide taxation for residents and the source taxation for non-residents is commonly accepted. Therefore the distinction between the taxation of resident and non-resident entities seems justified in the light of the principle of equality in European law.

3.6.3 WTO law Distinctions are made between resident and non-resident entities. This situation could be influenced by the national treatment rule, but due to the very limited scope of impact on direct taxation can be concluded that WTO law cannot eliminate the distinction between these taxpayers. The distinction between corporate and non-corporate entities is based on the fact that they are different forms of entities, different treatment follows from that logically. This does not fall within the scope of either the national treatment rule or the most-favourable nation treatment, since there is no cross-border situation.

3. Corporate versus non-corporate entities

3.6.4 Tax treaties (OECD-MC) The non-discrimination principle in the OECD-MC entails direct discrimination, so distinctions between domestic and foreign taxpayers are justified for they do not find themselves in the same circumstances. The distinctions that are made between resident taxpayers are not relevant, because there is no cross-border income in that situation. Furthermore the distinctions between non-resident taxpayers are based on the fact that these taxpayers are subject to different laws, corporate and personal income tax law. This works out the same as at the level of European law.

3.7 Neutral income tax regarding (non-)corporate entities

In Dutch literature many pleadings in favour of a neutral income tax regarding the taxation of corporate and non-corporate entities have been made by many different fiscal authors. The most important objections to the lack of a neutral taxation of corporate and non-corporate entities are the existence of two taxation systems for business profits, namely PITA and CITA, and the different tax tariffs in PITA and CITA.149 Depending on the legal form of a business it is taxed in either one of the systems. Pleadings therefore see to the desirability and often also to the feasibility of a neutral business profit tax, in which the legal form of an entity has no influence on taxation. In time, starting from 1960, a lot of fiscal literature, from either fiscal scientists or by committees installed by government order, that include or touch on this subject has been published in NL.150

With respect to a neutral taxation of the legal form, fiscal authors and government plead divergent opinions en visions. Several arguments pro introduction of neutral taxation regarding the legal form of an entity are defended in fiscal literature. The legislator does not intend to stimulate a certain legal form for an undertaking and it is commonly known that he should take a neutral position with respect to the legal form of an entity.151 Tax law should not have an impact on the choice of the legal form, the civil and economic aspects should determine the choice of the legal form. Due to the different treatment of business profits in PITA and CITA and the different effective tax rates that are a

149 An entrepreneur that is wholly taxed in PITA (Box 1) for business profits, is subject to a tariff of maximal 52%. Note: This might be reduced to an effective tax rate of 45,76% if a small or middle-sized entrepreneur is entitled to the profit exemption of 12% on the basis of art. 3.79a PITA. An entrepreneur of which business profits are first taxed in CITA with a tax rate of 25,5% and then taxed in PITA (Box 2) for distributions of dividends with a tax rate of 25%, has an effective tax rate of 44,125%. 150 S.J. Mol-Verver, FWR 10, De ondernemingswinstbelasting, Een zoektocht naar een rechtsvormneutrale wijze van winstbelasting, Amersfoort: Sdu 2008, p. 21-40. The proposition that came up in 1960 is Rapport van de belastingstudiegroep van het Katholieke Verbond van Werkgeversvakvereniging, Hervorming van de belastingheffing van ondernemingen, 1960. Other literature on this subject is among others beside the 1960 Rapport, J.E.A.M. van Dijck, Belastingheffing van ondernemingen ongeacht de rechtsvorm, Belastingconsulentendag 1984, FED: Deventer, 1984, F.H.M. Grapperhaus, De ondernemingswinstbelasting opnieuw van stal gehaald, TVVS 1985/4, p. 92-97, the (government) Committee Stevens in 1990, P.H.J. Essers, Knelpunten bij de hervorming van de belastingheffing van ondernemingen (inaugural lecture), Tilburg 1992, Report of the Ruding Committee of independent Experts on company taxation, European Comission, 1992, Y.N. Koudijs, Ondernemingswinstbelasting, Een rechtsvormneutrale belastingheffing naar de winst uit onderneming (dissertation), Amsterdam 1993, A.C. Rijkers. Rapport inzake een variant van de ondernemingswinstbelasting, bijlage 2 bij Advies inzake een ondernemingswinstbelasting, Raad voor het Midden en Kleinbedrijf, ‟s Gravenhage 1995 and E.J.W. Heithuis, Zonder aanzien des (rechts)persoons, De wet VPB 2007: De ondernemingsbelasting van de 21e eeuw (inaugural lecture), Rotterdam 2005. NB: This is a non-exhaustive list! 151 Y.N. Koudijs, Ondernemingswinstbelasting, Een rechtsvormneutrale belastingheffing naar de winst uit onderneming (dissertation), Amsterdam 1993, p. 185.

3. Corporate versus non-corporate entities consequence of this, the principle of global equilibrium is broken through.152 Moreover, due to this difference in effective tax rate the competitive position for undertakings is fiscally influenced. Profits are namely effectively taxed differently even though profits are, regardless of the legal form they are created in, substantially the same. Furthermore a neutral income tax shall contribute to the decrease of anti abuse measures, since the enlarged equality of taxation of profits no longer leaves room to make use of arbitrage between profits taxed in PITA and CITA. This will increase the legal certainty and the simplicity of the tax system.153 Above this, the Dutch legislator has established some fiscal measures in the last decades that improve a more neutral taxation with respect to the legal form.154 This confirms the tendency of the legislator to come to a more neutral taxation of entities. An additional argument in favour of a neutral income taxation is the desirability for the enlargement of equality of taxation of one-man businesses and partnerships on the one hand and companies with capital divided into shares on the other hand on the level of the European Union.155 Besides all of these arguments in favour of an income tax that is neutral regarding the taxation of corporate and non-corporate entities, it has not become reality up till today. The legislator uses different arguments against the various proposals that have come up in literature on a neutral income taxation, more specifically proposals of a business profit tax. In the past an argument was that a proportionate taxation as proposed in a business profit tax was inconsistent with the ability-to-pay principle. This principle is incorporated in Dutch PITA by the different sources of income that form a basis for taxation. A strict separation of these sources of income exists, so NL knows an analytical tax system. In the past this separation of sources of income did not exist, there was a synthetic tax system. Even though this argument was valid in the past, nowadays the analytical system justifies a separate taxation of business profits, for it is a different source of income.156 Another demerit of a business profit tax is the expected increase in the tax burden for smaller and middle sized undertakings. Besides that the government raises objections against the feasibility of a business profit tax, partly in the light of budgetary problems.157 Furthermore the international environment can lead to problems with the introduction of a business profit tax. The distinction between PITA and CITA exists all over the world and practical systems with a pure combination of personal income tax with a business profit tax do not exist.158 Problems that can arise in the field of international taxation have to do with double

152 Grapperhaus formulated this principle in the sixties of the previous century. It meant that a global equilibrium existed between the way business profits were taxed in both PITA and CITA. The fiscal legislator felt at that time this equilibrium existed. See respectively F.H.M. Grapperhaus, De besloten NV fiscaal vergeleken met de persoonlijke ondernemer en de open NV (dissertation), Amsterdam: FED 1996 and S.J. Mol-Verver, 2008, p. 52. 153 S.J. Mol-Verver, 2008, p. 55. 154 For example the alteration of the regime for substantial shareholders in 1997, the alterations in the tariff in PITA to align with the tariff in CITA in 2001 (which were undone later by additional alterations in 2007 and further) and the anti abuse measures of art. 3.91 and 3.92 PITA. 155 This proves from the Recommendation of 25 May 1994 of the European Commission, no. 94/390/EG. A basis for this can also be found in the working document of 2 June 1993 of the European Commission named „A strategic program for the internal market‟, no. COM/93/256/FINAL. 156 Y.N. Koudijs, 1993, p. 22 and S.J. Mol-Verver, 2008, p. 49. 157 Y.N. Koudijs, 1993, p. 22, S.J. Mol-Verver, 2008, p. 50, 52 and P.H.J. Essers, Een boekbespreking van de inaugurele rede Zonder aanzien des (rechts)persoons, De Wet VPB 2007: De ondernemingswinstbelasting van de 21e eeuw van E.J.W. Heithuis, WFR 2005/637. 158 Y.N. Koudijs, 1993, p. 80.

3. Corporate versus non-corporate entities

(non-)taxation and the difficulty to fit a business profit tax into the existing international network of tax treaties NL has.159 These contra arguments for a business profit tax have not created a sufficient base for fiscal scientists to abandon their pleads for a neutral income taxation. The arguments of the legislator are continuously criticized and in literature is searched for solutions to solve the problems arising with the introduction of a neutral income taxation.

In the proposals for a business profit tax several aspects are distinguished. All sources of income should be treated equally if they are equal and treated unequal to the extent of their inequality. Furthermore the imposition and collection of taxes should not have an influence on economic decisions of taxpayers. Of the various proposals, certain suppositions show great congruence. These are the assumption that all legal forms of entities are subject to the business profit tax, their tax base is the entire business profit, a proportional tariff counts and some sort of deduction for paid business profit tax is applied when personal income tax is levied.160 Additional criteria for a business profit tax are stated by Heithuis, namely the principle of simplicity, the demand to fit into international relations, the demand to follow civil law as much as possible and to keep the alteration as small as possible to the existing fiscal system.161 Several practical executions are thinkable and worked out in literature. The legislator therefore should have enough inspiration for the filling-in of a business profit tax, might NL ever come to that.

The desired level playing field with respect to a more neutral taxation of entities might be availed by a realisation of a business profit tax. All legal forms of businesses will be subject to tax for their profits under this business profit tax, regardless of their legal form. This would eliminate different taxation for profits generated by transparent versus non-transparent entities under respectively a personal income tax and a corporate income tax, to which they are subject now. Furthermore, this would significantly reduce qualification issues with respect to entities, since the qualification as a corporate or non-corporate entity would not matter for subjection to a certain tax regime. All entities would be subject to the business profit tax.162 In later chapters will be reverted to this business profit tax as a possible solution in relation to the neutral level playing field realizing a smaller influence of taxation on the choice of the legal form.

159 S.J. Mol-Verver, 2008, p. 45, 46. 160 Y.N. Koudijs, 1993, p. 185, 186. 161 E.J.W. Heithuis, 2005, p. 13, 14. 162 It goes beyond the scope of this thesis to describe the outline of such a business profit tax, how to deal with profit distributions, how to eliminate the distinction between shareholders that are entrepreneurs and shareholders that are financers and so on. In literature however several proposals have been made to shape such a business profit tax in the Dutch tax system. For this purpose is referred to Y.N. Koudijs, 1993, p. 131-135, E.J.W. Heithuis, 2005, p. 13-40 and S.J. Mol-Verver, 2008, p. 117-124. The proposal from Heithuis regarding the primacy at the level of corporate income tax as a liberating taxation in my opinion deserves special recommendation to be read.

3. Corporate versus non-corporate entities

3.8 Conclusion on qualification and taxation of (non-)corporate entities

The qualification of entities is broadly discussed. The criteria that are used for the legal qualification of domestic entities are the purpose, representation, authority and liability of the entity. These are the material aspects to determine whether or not an entity has corporate personality. The formal aspect that determines corporate personality is the civil indication in the DCC of which entities are corporate entities. This implies that most companies are not able to chose their legal form, they only have an influence on the described criteria as they are being established. However, if the upcoming amendment of law regarding partnerships follows through, it will become possible for a certain group of partnerships, namely the OV(R) and CV(R), to chose for corporate personality.163 The criteria that are used for the legal qualification of foreign entities are whether the entity can posses ownership, the liability of participants, whether the entity has a capital divided into shares and whether the participations are freely transferable.164 Determination on the basis of these criteria have the effect that the qualification of a lot of entities will be the same under both domestic and foreign law. The Dutch legislator uses foreign civil law to determine the legal position of the foreign entity and the participants. Then a decision whether this entity with these civil features has corporate personality by Dutch measures, is made according to Dutch fiscal criteria. In cross-border situations the treaty is the decisive factor for the qualification of entities. The existence of a treaty solves problems due to different qualification under domestic and foreign law. If a treaty between two countries does not exist, the Dutch unilateral decree for prevention of double taxation becomes relevant for Dutch residents or non-residents with Dutch income. If different qualification under domestic and foreign law arises due to the qualification in this unilateral act, which is based on Dutch law, the double taxation or double non-taxation that is a consequence of this, remains. The principle of equality as it is represented in constitutional law, European law, WTO law and tax treaties, has been evaluated in the light of its impact on different qualification of entities. The principle of equality in Dutch constitutional law only has a legal impact on „all persons in the Netherlands‟. Since no distinctions are being made in the criteria for determination of corporate personality between firstly purely domestic taxpayers and secondly between purely foreign taxpayers, no discrimination exists under constitutional law. In European perspective the Dutch qualification method for foreign entities is approved by the ECJ.165 This system might however lead to international different classifications of entities since states namely classify entities autonomously, tax classification in the other state is not taken into account. This can consequently possibly lead to double (non-)taxation. These classification differences could be resolved by the concept of mutual

163 Kamerstukken II, 2006-2007, 31 058, Wet vereenvoudiging en flexibilisering bv-recht. 164 Decision of 11 December 2009, nr. CPP2009/519M. 165 G.K. Fibbe, 2009, p. 98-100.

3. Corporate versus non-corporate entities recognition. In the EU however, the scope of this principle is restricted to the treaty freedoms. In Columbus Container Services166 however, it became clear that Member States are highly free to determine the classification for foreign entities themselves. This does not contribute to the swiftness of an international solution for the classification problem. WTO law entails the non-discrimination principle, worked out in the most-favoured nation treatment and the national treatment rule. NL does not make distinctions between foreign taxpayers and is therefore compliant with the most-favoured nation rule. Regarding the national treatment rule can be said that the different qualification of domestic and foreign entities in NL could be out of line with the non-discrimination principle in WTO law. Since there is however no commitment from NL to equal treatment of services with respect to qualification related issues of entities, the distinction between domestic and foreign situations seems justified. Furthermore in the OECD Commentary is suggested in order to solve classification issues that subjective qualification should be dependent on the qualification in the resident state, as objective qualification should be dependent on the qualification in the source state. Even though this is a good solution in the light of the principle of equality, it unfortunately cannot be enforced before court.

The taxation of corporate versus non-corporate entities and their shareholders has been reviewed. Domestic entities are subject to corporate income tax for their worldwide income based on art. 2 (5) in conjunction with art. 7 CITA. The criterion for resident entities to be subjected to corporate income tax is whether they are established in NL, based on the actual circumstances.167 Besides that, foundation in NL can also be sufficient to be qualified as a domestic entity, also called the deemed place of establishment.168 For non-resident entities the criterion of subjection is whether they generate specific Dutch income, which then is taxed on the basis of art. 17 and art. 17a CITA. These criteria for subjection do not match the criteria for determining corporate personality. In the taxation of entities subjection to personal or corporate income tax makes a difference for the shareholders or partners, just as residency of entities is relevant. This can be read in the following tables: Domestic situation Dutch entity Dutch transparent entity Cross-border situation Shareholder: natural person < 5%  1,2% art. 2.1 icw 5.1 PITA* Results allocated to shareholders  < 5%  1,2% art. 2.1 icw 7.7 PITA* max. 52% art. 2.1 icw 3.1 PITA  5%  25% art. 2.1 icw 4.1 PITA* Results allocated to shareholders   5%  25% art. 2.1 icw 7.5 PITA* max. 52% art. 2.1 icw 7.2 PITA Shareholder: entity < 5%  20-25,5% art. 2 icw 7 CITA* Results allocated to shareholders  < 5%  20-25,5% art. 3 icw 7 CITA* 20-25,5% art. 2 icw 7 CITA  5%  0% art. 13 CITA Results allocated to shareholders   5%  0% art. 13 CITA 20-25,5% art. 3 icw 7 CITA * Dividend tax is a withholding tax on the basis of art. 9.2 PITA respectively art. 25 CITA

166 ECJ 6 December 2007, C-298/05 (Columbus Container Services). 167 Art. 2 (1) CITA in conjunction with art. 4 (1) General law on taxation. 168 Art. 2 (4) CITA.

3. Corporate versus non-corporate entities

The impact of the principle of equality as it is represented in constitutional law, European law, WTO law and tax treaties on the taxation of entities has been evaluated. In constitutional law the differences between domestic corporate and non-corporate entities result in taxation in different law systems, respectively CITA and PITA. Furthermore the different treatment of shareholders or partners of corporate or non-corporate entities arises from the difference between the legal forms of these entities, leading to subjection in either CITA or PITA. This might form an unjustified discrimination, since the basis for these different tax laws is debatable. Regarding European tax law, WTO law and tax treaties, only cross-border situations are relevant. Therefore in all three systems different treatment of resident corporate and non-corporate entities is irrelevant. The different treatment of corporate and non-corporate non-resident entities comes forth out of their subjection to different laws. Then the same conclusion as to constitutional law applies. Furthermore the distinction in taxation between resident and non-resident entities comes fourth out of respectively unlimited tax liability and limited tax liability, which is accepted in European law. In Dutch literature an extensive discussion on the desirability and feasibility of an income tax that is neutral regarding the legal form of an entity has taken place. Different taxation systems, namely personal income tax and corporate income tax, also knowing different tax tariffs, are the main cause for that. Despite extensive pleadings in favor of a neutral income tax, more specifically a business profit tax, it does not exist in NL. Valid counterarguments are the expected increase in tax burden for smaller and middle sized businesses, unfeasibility of a business profit tax in the light of budgetary problems and possible double (non-)taxation problems in international context, where a system like this is unknown. The desire to create a tax system that is neutral to the choice of the legal form however still continues. Moreover, a business profit tax might contribute to reaching a more neutral taxation of legal forms, which is needed in the light of the principle of equality in the desired level playing field.

From this broad description of topics regarding corporate versus non-corporate entities and their evaluation in the light of the principle of equality in taxation, the topic qualification of foreign entities will be further discussed in Chapter 5. Regarding the existing different qualification methods for foreign entities and the difficulties with respect to double (non-)taxation as a consequence of classification conflicts with hybrid entities, a legal comparison and a review of existing approaches in the different law systems will provide for a way to think of how the neutral level playing field can best be reached as regards this topic.

4. Permanent establishment versus subsidiary

4.1. Introduction

In the following chapter the permanent establishment and the subsidiary and their comparability will be discussed. Before focussing on the inbound investments, outbound investments and funding issues from a Dutch perspective, to come to a clear understanding of what the PE and the subsidiary imply, they will be generally discussed. A description of both the definitions of the PE and the subsidiary in NL are included and how they relate to each other. This general part is meant to create a global image of the situation in NL. After a brief introduction the PE and subsidiary are elucidated in more detail and with a broader range of subject. In each part respectively the topics inbound investments, cross-border loss relief and funding, will be evaluated in the light of the theoretical framework regarding the principle of equality in taxation. At the end of the chapter a conclusion is given. This chapter will give an insight as to how the PE and the subsidiary relate to each other in the Dutch tax system in terms of equality, also in the light of the different law systems. Furthermore it will contribute to the ability to judge whether or not and if so, in which areas, more neutrality is needed between the PE and the subsidiary in the light of the desired level playing field regarding the different legal forms of businesses.

4.1.1 Permanent establishment A PE is merely a fiscal concept, it does not exist in civil law. Therefore the meaning of this term is to be found in tax law. In Dutch corporate income tax a definition of a PE however does not exist. Interpretation of the terminology consists mostly of interpretation of characteristics of PEs in case law and partly by interpretation from definitions in the unilateral tax treaties, such as the unilateral decree for prevention of double taxation and the Tax Act for the Kingdom of the Netherlands (Belastingregeleing voor het Koninkrijk der Nedelanden, hence: TKN).169 A PE is described in art. 2 (1) of the unilateral decree for prevention of double taxation as a fixed place of business through which the business of an enterprise is wholly or partially carried on, including the seat of the management of the undertaking, forest grounds and works of which the execution takes longer than twelve months. This is almost equal to the definition in art. 2 (1) (e) TKN, which describes a PE as a fixed place of business through which the business of an enterprise – independent professions included – is carried on. Furthermore art. 2 (2) respectively (3) TKN include some examples of what is qualified as a PE and what cannot be qualified as a PE. This description of a PE largely corresponds with the definition of a PE in the OECD-MC in art. 5 (1). The OECD-definition is that a PE is a fixed

169 Although, these definitions don‟t entirely match the interpretation of the permanent establishment in Dutch tax law. .H. de Vries and R.J. de Vries, 2008.

4. Permanent establishment versus subsidiary place of business through which the business of an enterprise is wholly or partially carried on. The article also names some forms that are qualified as a PE and also excludes certain cases as a PE. In NL the requirements to qualify as a PE are formed in case law, namely the presence of a physical construction that is legally or actually available for the business and that is organized for the business that is carried on in it and that is permanently available for the taxpayer.170 Even though the Dutch terminology for a PE is not completely the same as the definition in the OECD-MC, both descriptions largely match.171

4.1.2 Subsidiary A subsidiary is a term that is defined in civil law. Art. 2:24a (1) DCC describes the subsidiary of a legal person: (sub a) „a legal person in which the legal person or one or more of its subsidiaries, pursuant to an agreement with other persons entitled to vote or otherwise, can exercise, solely or jointly, more than one half of the voting rights at a general meeting‟ or (sub b) „a legal person of which the legal person or one or more of its subsidiaries is a member or shareholder and, pursuant to an agreement with other persons entitled to vote or otherwise, can appoint or dismiss, solely or jointly, more than one half of the directors or officers or of the supervisory board members, if all persons entitled to vote were to cast their vote‟. Furthermore art. 2:24a (2) DCC states that a partnership acting in its own name, for the obligations of which the legal person or one or more subsidiaries is, as a partner, fully liable to obligations, shall be treated as a subsidiary. This definition of a subsidiary is also valid for tax law. In tax law a subsidiary is a legal independent entity, a business with a separate identity that has rights and duties of its own. For the application of certain delegations in tax law however, the concept of alliance of two entities is more specific described in the relevant provisions. Three sorts of divisions can be distinguished next to the definition of a subsidiary in civil law. For the qualification as a subsidiary in a fiscal unity art. 15 (1) CITA in conjunction with art. 1 (2) (c) Decision Fiscal Unity (Besluit Fiscale Eenheid 2003) determines that legal and economic ownership of at least 95 percent of the shares in the nominal paid capital of the other taxpayer is mandatory. Taxes are levied upon the parent company as if there were one taxpayer, including the subsidiary.172 Another term in tax law is associated entities. This is described in art. 10a (4) CITA as an entity in which the taxpayer holds at least a one third interest. Associated entities are eligible for certain tax provisions. The description in art. 10a (4) CITA is according to the article also applicable to several other provisions in CITA.173 A third stipulation to be named is art. 13 (2) CITA. An entity is qualified as a participation if a taxpayer holds at least 5 percent of the shares of the nominal paid capital of an entity with capital divided into shares. This

170 L.W. Sillevis, M.L.M. van Kempen and G.W.B. van Westen, Cursus belastingrecht, Inkomstenbelasting 2009-2010, Deventer: Kluwer 2009, section 7.2.1.A. 171 For a clear overview for differences between the two descriptions see L.W. Sillevis, M.L.M. van Kempen and G.W.B. van Westen, 2009, section 7.2.1.B and Dutch Branch Report in J. Sasseville, A. Aage Skaar, and P. Baker, Is there a permanent establishment?, Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2009. (Cahiers de Droit Fiscal International, Volume 94a). 172 This provision is only applicable at request. Furthermore more than one subsidiary can take part in the fiscal unity of a parent company. 173 Named in art. 10a paragraph 4 CITA: Artt. 10, 10d, 13, 13a, 13b, 13ba, 13c, 13d, 13e, 13j, 13k, 14, 14a, 17a, 20, 28 and 33 CITA.

4. Permanent establishment versus subsidiary leads to application of the participations exemption. These descriptions are relevant for the specific provisions, the civil definition of a subsidiary is in principle by analogy applicable in tax law.

In the comparability of a PE and a subsidiary the difference in meaning of these notions is important. In the tax law the provisions that are applicable to either one of these legal forms explicitly constitute the legal form of subject. If a subsidiary is established in NL, it is subject to corporate income tax on the basis of art. 2 CITA. If a subsidiary of a Dutch parent company is established abroad, the participations exemption is applicable under certain conditions and therefore foreign profits and losses are exempt on the basis of art. 13 CITA. If a PE is set up in NL, NL will levy tax upon the income that is generated by this PE at the level of the head office by art. 3 in conjunction with art. 17 (3) (a) CITA.174 Vice versa this will happen if an entity in NL holds a PE abroad. NL will give a tax relief for this foreign income of a Dutch head office, after including it in the tax base of the head office.175 This difference constitutes that a subsidiary is subject to corporate income tax based on its legal independency in civil law, while the income of a PE is subject to corporate income tax as an extension of the head office.176 The profit attribution to a PE determines the amount of profit that is accounted to it. This will later be discussed in detail.

In general the view on a subsidiary versus a PE in NL is that they both can constitute the same business activities, but are different legal forms.177 The subsidiary is a separate entity, linked to the parent company and the PE is a part of the general company. Depending on the qualification as either one of these, certain specific rules regarding tax provisions become applicable.

4.2 Inbound investments

In this section aspects of inbound investments of a PE versus a subsidiary are described based on the Dutch treatment in CITA. Subjects that are discussed are the comparability of eligibility to treaty benefits, profit determination and tax rate, the Dutch group taxation system and the possibilities for pooling profits and losses within that and at last the impact of the principle of equality in taxation on these inbound investments is evaluated. By the treatment of inbound investments and the comparison of a PE to a subsidiary and the impact of the principle of equality on this, it will become possible to review whether this is justified in the light of the neutral level playing field.

174 NL taxes non-resident entities for their source income generated in NL. 175 NL taxes resident entities for their worldwide income and grants tax relief for foreign source based income. 176 Conclusion Advocate General Wattel, 4 July 2007, nr. 43484, VN 20007/47.16, point 6.10. 177 This vision already exists a long time in NL, see G.J. van Leijenhorst, Dochtermaatschappij en vaste inrichting, een juist onderscheid?, WFR 1987/321.

4. Permanent establishment versus subsidiary

4.2.1 Double tax treaty access To gain access to a double tax treaty it is necessary to be a resident of one or both of the countries in question.178 The term resident is described in art. 4 (1) OECD-MC: „Resident of a Contracting State means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. This term however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.‟179 Furthermore art. 4 (3) OECD-MC states that: „Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated.‟ The reference in the article to „any person who is liable to tax under the laws of that State‟ means that national law concerning the subjective unlimited liability serves as the basis for which persons can be seen as residents. More specific art. 3 OECD-MC describes „persons‟ as individuals, companies and other bodies of persons. „Companies‟ are bodies corporate or entities that are treated as bodies corporate for tax purposes. Based on art. 2:24a DCC a subsidiary is a legal person. Therefore a subsidiary has access to the double tax treaty on the basis of its residence. PEs cannot be qualified as „companies‟, since they do not posses corporate personality. Therefore they do not fall under the definition of residents in the double tax treaty. Furthermore a PE is not liable to tax by reason of its domicile, residence, place of management or any other criterion of a similar nature, as stated in art. 4 (1) OECD-MC. Moreover, the last sentence of art. 4 (1) OECD-MC explicitly states that persons liable to tax only of income sources in that State are not included in the term residents. Therefore PEs don‟t have access to double tax treaties.180

Since Saint-Gobain181, however, the same right to treaty advantages is reserved to PEs as they are to residents, as long as the object of taxation is taxed identically for both taxpayers without the residency being of interest. Saint-Gobain ruled that foreign capital entities with a permanent establishment in Germany were disadvantaged for certain fiscal privileges compared to German unlimited taxpayers. This restriction formed an unjustifiable impediment to permanent establishments of capital entities in Germany. The Court decided that the limited interpretation of the concept „resident in a treaty‟ conflicted with community law. Member States needed to enlarge the subjective working sphere of tax treaties to permanent establishments. By this ruling it became possible for permanent establishments to claim treaty eligibility in the State it was actually carried out in through the non-discrimination clause of the double tax treaty.

178 Henceforth the OECD-MC will be used as the considered double tax treaty, unless stated otherwise. 179 With respect to the term „any other criterion of similar nature‟ NL interprets this including entities that are incorporated in NL, with their effective place of management abroad. See C. van Raad, Cursus Belastingrecht, Internationaal Belastingrecht 2009-2010, Deventer: Kluwer 2009, section 3.2.4.B.b. 180 This is confirmed by the State secretary of Finance in the Decree of 21 January 2004, nr. IFZ2003/558M. 181 ECJ 21 September 1999, C-307/97 (Saint-Gobain) with conclusion from Advocate General Mischo 2 March 1999.

4. Permanent establishment versus subsidiary

The Dutch legislator has published the application of Saint-Gobain in a Decree in combination with a decision of the Dutch Supreme Court for Dutch tax law.182 The State secretary of Finance states that a Dutch PE of a foreign entity can offset foreign taxes for dividends, interest and royalties, attributable to the PE, to Dutch taxes on this unearned income abroad (withholding tax). This however is only applicable if a Dutch domestic taxpayer could also offset foreign taxes on unearned income abroad to Dutch taxes upon this income on the basis of a double tax treaty. Furthermore the scope of this Decree is enlarged to non-EU countries that have concluded a double tax treaty with NL that contains a non-discrimination clause. In the framework of treaty access this means that as long as an item of income is taxed independent from the residency of the taxpayer, the connected advantages to that item of income should be appointed independent to the residency of the taxpayer.183 This resulted in an important increase for the access of PEs to the advantages of a double tax treaty. The PE now has limited access to treaty benefits via the non-discrimination clause in the double tax treaty.

4.2.2. Profit determination and tax rate The head office and the PE are one corporate entity, the PE is a part of the general undertaking. For tax purposes the PE is qualified as a separate undertaking or a separate part of an undertaking.184 In general the sound business practice is the basis for profit determination in tax law.185 This is also the basis for profit attribution to a PE.186 In the determination of profit attributable to the PE in NL, the PE is considered to be a „functionally separate entity‟. The interpretation of this term in NL is almost equal to the interpretation the OECD uses.187 The OECD describes the „functionally separate entity‟ approach as follows: „The profits to be attributed to a PE are the profits that the PE would have earned at arm‟s length if it were a legally distinct and separate enterprise performing the same or similar functions under the same or similar conditions, determined by applying the arm‟s length principle under article 7 (2) OECD-MC.‟188 A comparable description of the profit determination rules for a PE is recorded in art. 7 (2) OECD-MC. In NL this assumption of a legally distinct and separate enterprise is slightly nuanced.189 Development in Dutch case law has led to the approach of a limited distinct and separate entity approach for the PE.190 In BNB 1997/263 is explicitly said that the Dutch Supreme Court assumes „the fiction that the permanent establishment constitutes a separate entity‟.

182 Decree of 21 January 2004, nr. IFZ2003/558M and Hoge Raad 8 February 2002, nr. 36155, BNB 2002/184. 183 E.C.C.M. Kemmeren, Verdragsvoordelen niet alleen meer voor inwoner maar ook voor vaste inrichtingen, WFR 1999/1429. 184 In international perspective this is the most used method for profit determination of PEs, see I.J.J. Burgers, Een boekbespreking van ‘The attribution of profits to permanent establishments, International Fiscal Association’, WFR 2006/1301. 185 See for example art. 3.8 in conjunction with art. 3.25 PITA and art. 7 and art. 8 CITA. 186 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 1), WFR 2003/1965. 187 OECD, Report on the Attribution of Profits to Permanent Establishment, OECD, Paris 2008, p. 12 and Dutch Branch Report in J. Sasseville, A. Aage Skaar, and P. Baker, Is there a permanent establishment?, Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2009. (Cahiers de Droit Fiscal International, Volume 94a). 188 This is approach rejects the force of attraction, just as the Dutch Supreme Court does. 189 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 1), WFR 2003/1965. 190 Hoge Raad 4 May 1960, BNB 1960/167, Hoge Raad 12 February 1964, BNB 1964/95, Hoge Raad 23 January 1974, BNB 1986/100 and Hoge Raad 7 May 1997, BNB 1997/263.

4. Permanent establishment versus subsidiary

In order to establish this assumed legal independency of a PE for the profit attribution, a functional and factual analysis of activities and responsibilities of the PE is used. In NL the criterion of subservience is decisive for the attribution of an asset or liability and the profits and losses resulting from these.191 The balance sheet of the PE is hereby the starting point for allocating profit and capital to the PE.

In this light the profit of a whole undertaking, including the PE, is established each year. By this yearly taxation is attempted to levy tax upon all profits of the entity during its entire lifetime once, in separate time fragments.192 NL levies tax on the worldwide income of the corporate entity on the basis of art. 2 in conjunction with art. 7 CITA. Subsequently the income of the foreign PE is exempt on the basis of either a double tax treaty or the unilateral decree for prevention of double taxation. Therefore if the a profit repatriation in a later year takes place from the PE to the head office, it is effectively not taxed in NL. The profit repatriation to the head office is not subject to any branch profit tax. Since it has already been included in the Dutch tax base in an earlier year and was exempt from taxes, it otherwise would mean a double taxation of one object.

The profit determination of a subsidiary as a distinct legal entity is based on art. 2 in conjunction with 7 CITA. The taxable profit is the in one year enjoyed profit deducted with accountable losses and deductable donations. The tax rate that is applicable to this taxable profit is 20% for the profit between € 0,- and € 200.000,- and 25,5% for all profit above € 200.000,- according to art. 22 CITA. The profit of a PE is determined in NL on the basis of art. 3 in conjunction with 17 (3) CITA. Determination of the taxable profit of a PE is based on the limited distinct and separate entity approach, comparable to the „functionally separate entity‟ approach used by the OECD as already described. The tax rate is the same as for subsidiaries. The difference thus is that the profit determination of a PE depends on the criterion whether an asset or liability is subservient to the PE. There is no legal distinct entity, as opposed to the subsidiary. All assets and liabilities of the subsidiary are allocated to it, since it is a legal distinct entity.

4.2.3 The fiscal unity In NL the group taxation system is shaped into the fiscal unity. Firstly the fiscal unity will be explained in short and the situation in which PEs in NL can take part in this fiscal unity. Then the possibilities for pooling domestic profits and losses are discussed by means of a clear overview of the cross-border loss relief possibilities.

191 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 1), WFR 2003/1965, who also refers to case law in which this theory is established. 192 See art. 3.8 PITA for the concept of all profits in an entire lifetime and art. 3.25 PITA for the segmentation of these profits in to yearly fragments.

4. Permanent establishment versus subsidiary

The Dutch group taxation system is the fiscal unity, recorded in the law in art. 15 CITA et seq.193 On the basis of art. 15 (1) CITA it is possible to enter into a fiscal unity, at joint request, if a corporate entity (parent company) legally and economically owns 95% or more of the shares in the subsidiary. Then art. 15 (3) CITA states that application of paragraph 1 is only possible if both taxpayers are subject to the same profit determination provisions and if both are established in NL or if they meet the requirements in art. 15 (4) CITA.194 This comes down to the requirement that if a foreign taxpayer conducts business in NL through a PE, it can be part of the fiscal unity as far as the profits from that PE are allocated to NL on the basis of a double tax treaty. Subsequent requirements are that the effective place of management of the foreign taxpayer is not in NL195, the taxpayer is a company limited by shares (NV) or a private company with limited liability (BV) or an entity comparable to these and if the parent company is abroad, the share ownership of the Dutch subsidiary can be allocated to the activities of the PE in NL. The following pictures will clarify these situations.

The Dutch entities and the Dutch PEs in both structures can enter into a fiscal unity if they meet the above described requirements.196 The second situation is very difficult to prove in practice, since in order for the PE to enter into the fiscal unity the shares of the subsidiary need to be allocated to the PE instead of to the head office abroad.197 This effectively means that the shares of the subsidiary in NL should be subservient to the PE in NL and not to head office abroad.

If a fiscal unity is established, the joint entities are consolidated. The activities and capital of the joint entities are allocated to the head of the group, either the Dutch parent company or the Dutch PE of the foreign parent company. It then amongst others becomes possible to offset losses between the

193 For an extensive description of the fiscal unity is referred to J.A.G. van der Geld, Hoofdzaken vennootschapsbelasting, Deventer: Kluwer 2009, Chapter 10 and Q.W.J.C.H. Kok, FWR 5, De fiscale eenheid in de vennootschapsbelasting, Amersfoort: Sdu Fiscale en Financiële Uitgevers 2005. 194 B.J. Kiekebeld and J.A.R. van Eijsden, 2009, p. 131 shows that the Dutch fiction of establishment in art. 2 (4) CITA is not applicable to companies in a fiscal unity. A cross-border fiscal unity is not possible with dual resident entities. 195 More precise art. 15 paragraph 4 sub a CITA states that the place of effective management of the entity should be in the Netherlands Antilles, Aruba, a Member State of the European Union of a state with which NL has concluded a double tax treaty that includes a provision that prohibits the discrimination of permanent establishments. 196 On the basis of art. 15 (4) CITA in conjunction with Chapter VII Decision Fiscal Unity (Besluit Fiscale Eenheid 2003). See also Q.W.J.C.H. Kok, 2005, p. 108-118 and 340-361. 197 In this situation the Decree of 21 January 2004, nr. IFZ2003/558M and Hoge Raad 8 February 2002, nr. 36155, BNB 2002/184 give the right of taking the foreign tax on unearned income abroad for dividends, interest and royalties that are attributable to the PE into account. This will decrease the total tax burden of the Dutch fiscal unity.

4. Permanent establishment versus subsidiary joint entities.198 In a fiscal unity taxes are levied at the level of the parent company as if there is one taxpayer on the basis of art. 15 CITA.199

4.2.4 Pooling profits and losses within fiscal unity In the light of the described system above, pooling domestic profits by the entity of which the PE is a part is possible to the extent that the head office can influence the profit determination. More precise, if the head office can influence the subservience of assets or liabilities to the PE, it can influence the pooling of the profits to the PE.200 For the pooling of losses of a Dutch PE, the basis of determination of the tax base in NL and the Dutch method of tax relief are important. NL levies taxes upon its residents on the basis of their worldwide income, including the income of the PE. In a cross-border situation the double tax treaty allocates business profits of a PE to the source state on the basis of the „functionally separate entity‟ approach.201 If a foreign PE of a Dutch resident entity generates a loss, this loss however directly decreases the tax base of the Dutch resident entity.202 This cash flow advantage implies a temporary asymmetrical treatment in NL of profits and losses of PEs.203 Losses of the PE temporarily decrease the taxable profit in NL, while profits of the PE are exempt. If the PE returns to profitability in future years again, the losses are recaptured by granting a smaller tax relief in profitable years. On the other hand, a Dutch PE of a foreign entity is only taxed if and insofar it generates Dutch income. For the profits of the Dutch PE a tax relief is granted by the state of residence, since the latter state will first include these profits in the tax base of the foreign entity. If the PE does not generate Dutch income, it is not liable to tax in NL. It depend on system of the state of resident of the Dutch PE, which tax relief method is applied. If the same method is applied that NL uses, the losses of the Dutch PE would directly decrease the tax base of the foreign entity.

A tax relief for income, both positive and negative, attributed to the PE, is granted to prevent double taxation. Two methods of tax relief exist, namely the credit method and the exemption method.204 On the basis of the credit method the foreign taxes are deducted from the domestic tax base. By this method all losses are taken into account when determining the worldwide income, since they decrease the tax base of the total entity. On the basis of the exemption method, the income of the PE is exempt from tax. If a country grants a tax exemption, it is possible to either exclude or include losses of foreign PEs. When excluding losses, the system is balanced with the exclusion of profits

198 This is horizontal loss relief, within one year over more than one entity. See also art. 12 Decision Fiscal Unity. If losses of an entity are deducted from the profit of the entity in others years, it is vertical loss relief. See also N.H. de Vries and R.J. de Vries, 2008, section 4.0.0. 199 This also has as a consequence that internal debt relations in the fiscal unity are not visible for tax purposes. Internal loans will be explained in Chapter 7. See Q.W.J.C.H. Kok, 2005, p. 147-148. 200 Note that NL and the other state can possibly determine the profit of the PE slightly different, which may result in double taxation or double non-taxation for specific parts of the income of the entity of which the PE is part. 201 Art. 7 OECD-MC. From the Commentary on art. 7 OECD-MC, paragraph 1, nr. 11, can be deduced that art. 7 OECD-MC is both about positive as well as negative profits. So this article also entails the attribution of losses. 202 The system of taking losses of a foreign PE into account at the level of the Dutch head office is recorded in art. 35 Unilateral decree on the prevention of double taxation. 203 J.A.G. van der Geld, 2009, section 10.5.1. 204 See art. 23a and 23b OECD-MC.

4. Permanent establishment versus subsidiary from the tax base.205 Profits and losses are treated equally. When including losses, this is applied in combination with recapture measures for when the PE returns to profitability again. This is executed by decreasing the tax relief at a later time.206 NL also uses this system and lets the tax exemption depend on an objective or actual subordination in the other state.207 Losses of the foreign PE immediately decrease the tax base of the Dutch head office.208 The latter system can lead to a temporary double non-taxation in the form of temporarily offsetting losses twice. Even though the double loss relief is balanced when the losses are offset to profits in later years in the resident state, temporary double non-taxation still remains.

4.2.5 Evaluation: equality and inbound investments In this next paragraph the effect of the principle of equality in taxation on the described inbound investments. Subsequently equality in relation to double tax treaty access, taxation of profit repatriations and the Dutch PE in the group taxation system are elaborated.

4.2.5.1 Equality and double tax treaty access In constitutional law the PE is not known as a legal form. The PE is merely a fiscal concept in order to establish profits and losses to be attributed to that part of the total undertaking. The principle of equality in constitutional law therefore does not have an influence on double tax treaty access. The principle of equality in European law clearly does have an effect on double tax treaty access. Saint-Gobain209 made it clear that in the light of the freedom of establishment, PEs have a right to the advantages of double tax treaties through the non-discrimination clause of the double tax treaty, as long as the object of taxation is taxed identically as it is taxed with corporate entities.210 This has led to a more equal treatment of a PE in comparison with a subsidiary.211 It is debatable how far this development will eventually go.

Double tax treaties settle the division of taxing rights between countries in cross-border situations. The OECD-MC describes residency and determines which persons and companies have treaty access. As is made clear, PEs generally don‟t have access to the treaty while subsidiaries do. Furthermore art. 24 (3) OECD-MC constitutes a non-discrimination obligation towards PEs in comparison with other entities. This non-discrimination clause sees to the no less favourably levying of taxes upon a PE in comparison with other entities. NL does not comply to this non-discrimination rule, since in certain

205 In the EU seven Member States know a system that does not take losses of a foreign PE into account. See Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final, par. 2.2. 206 Five Member States do take losses of a foreign PE into account, with measures for catching up when the PE becomes profitable again. See Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final, par. 2.2. 207 See art. 32 Unilateral decree on the prevention of double taxation. 208 The observations to the articles, art. 35 Besluit voorkoming dubbele belasting 2001, aant. 2. The calculation of the exemption is worked out in detail in the observations to the articles. 209 ECJ 21 September 1999, C-307/07 (Saint-Gobain). 210 For the specific application in Dutch situations see Decree of 21 January 2004, nr. IFZ2003/558M. 211 N.M. van der Wal, Vaste inrichtingen en het gemeenschapsrecht: enkele kwetsbare onderdelen van de Nederlandse regelgeving, WFR 2009/436.

4. Permanent establishment versus subsidiary articles of the Dutch CITA, establishment in NL is required to gain access to a certain provision.212 This is discriminating in comparison with PEs of foreign entities, that cannot be established in NL.213

4.2.5.2 Equality and taxation of profit repatriations Constitutional law does not recognize PEs as distinct entities, PEs are merely fiscal phenomena. For tax considerations, in order to allocate profits, assets and liabilities to the PE, it is qualified in NL as a limited distinct and separate entity. This approach is somewhat narrower than the OECD-MC‟s functionally separate entity approach. Kemmeren states that this mostly influences the treatment of internal debt.214 For the treatment of profit repatriations, the difference in treatment of PEs between the Dutch approach and the approach in the OECD-MC is not of impact on the principle of equality. Apart from that can be said that NL does not levy an additional tax, such as a branch profit tax, on profit repatriations from a PE to a head office. This is due to the fact that all results of the PE are only included in the tax base of the total entity once. Since the PE is a part of the total entity and not a separate entity that can make profit distributions, this is justified in the light of the principle of equality.

4.2.5.3 Equality and Dutch PE in group taxation system Regarding equality in constitutional law the same conclusion about the impact of the principle of equality is applicable as the previous two sections. As described earlier, the Dutch group taxation system is the fiscal unity, in which a Dutch PE of a foreign entity can be included under certain conditions. For the pooling of profits it can be concluded that a roughly equal treatment exists for PEs in comparison with subsidiaries. The taxable amount of a subsidiary is established on the basis of its independency. The taxable profit of a PE is established on the basis of the limited distinct and separate entity approach, which practically qualifies the PE as a separate entity for tax purposes. These approaches are comparable, with the exception that the PE is merely a separate entity by fiction. Eventually all results of the PE are absorbed in the result of the entity it belongs to, after which the resident state grants a tax relief for the part of the profit that is attributable to the PE. This is related to the fact that the PE legally is not a separate entity, while the subsidiary is. Furthermore in the aspect of pooling profits, the method of tax relief of the resident state is relevant. The exemption method does not lead to an inequality. The credit method, however, might lead to an inequality. This inequality might exists in the case the source state has a lower tax rate than the resident state. The higher tax rate in the resident state then leads to additional taxation of the profits of the PE. The source state‟s taxes can be credited against the higher amount of payable taxes in the resident state due to the higher tax rate. The ECJ has stated that it is the right of countries to

212 For example art. 15 paragraph 3 and art. 28 CITA. See respectively Q.W.J.C.H. Kok, 2005, p. 108-112 and B.J. Kiekebeld and J.A.R. van Eijsden, 2009, p. 149-151. This is also described in paragraph 2.5. 213 C.A.T. Peters, Non-discrimination at the crossroads of international taxation – Dutch Branch Report, in L. Hinnekens & P. Hinnekens, Non-discrimination at the crossroads of international taxation (p. 407-426), Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2008. (Cahiers de Droit Fiscal International, Volume 93a), p. 413, explains that this might also be out of line with the fundamental freedoms of the TFEU. 214 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 1), WFR 2003/1965.

4. Permanent establishment versus subsidiary determine their tax rates themselves.215 This is however not a reason to stop questioning whether the different methods are fair.

Regarding the pooling of losses it can be said that a system symmetrical to the pooling of profits is desirable. Losses of a PE are, just like profits, allocated to the source state. The resident state is expected to grant a tax relief by either the credit or the exemption method. All losses are taken into account when applying the credit method and no discrimination exists. With respect to the exemption method however, the resident state can choose to either exclude or include losses of the foreign PE in the taxation at the level of the entity. When taking losses of the PE into account, together with recapture measures for when the PE becomes profitable again by decreasing the tax exemption in those years, the possibility of offsetting losses temporarily twice arises. If the recapture measures cannot be applied anymore, for instance if the PE does not exist anymore or never becomes profitable again, by this tax relief method permanent double non-taxation exists. It is arguable whether this is intended. When comparing this system to the loss winding scheme, there is an inequality.216 In that system the losses that can be offset, cannot be offset anywhere or anytime else. In contrary to the situation with a PE that is „liquidated‟, there is no double non-taxation. In European perspective can be evaluated whether a system of exclusion or (temporary) inclusion of losses of a PE is desirable. Advocate General Sharpston has concluded in Lidl Belgium217 that a system of complete exclusion of losses is an infringement to the freedom of establishment of art. 49 TFEU, since the measure is more restricting then necessary for the accomplishment of a balanced distribution of taxing rights and to avoid double loss relief. She finds the system in which losses are taken into account and offset to profits in later years by reducing the tax relief in those years, more justifiable. The ECJ did however not follow this conclusion in its judgement in Lidl Belgium.218 The ECJ established a restriction of the freedom of establishment in the situation in which losses of a foreign PE cannot be offset to profits of the head office on the basis of the exemption method, by which the results of the PE are excluded from the tax base of the head office compared to a situation in which losses of a domestic PE can be offset to profits of the head office.219 The Court has approved two grounds of justification for the existing restriction, namely the balanced distribution of taxing competence of Member States and the prevention of double loss relief. The Court considers these grounds justifiable, since the source state foresees in a measure that enables vertical loss relief for the PE. Even though the existence of two different systems leads to a form of inequality, this is accepted

215 E.C.C.M. Kemmeren, Exemption method for PEs and (major) shareholdings best services: the CCCTB and the internal markets concerned, EC Tax Review 2008/3, in which is referred to case law from the ECJ on this subject. 216 The regulation for losses made on liquidation is explained in more detail in the paragraph on outbound investments. 217 ECJ 15 May 2008, C-414/06 (Lidl Belgium) with conclusion from Advocate General Sharpston 14 February 2008. 218 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 219 ECJ 15 May 2008, C-414/06 (Lidl Belgium), point 26.

4. Permanent establishment versus subsidiary by the ECJ. The cash flow disadvantage that arises due to the exemption method with exclusion of losses for cross-border situations compared to national situations, is accepted.220

4.3 Outbound investments

In the following section aspects of outbound investments of a PE versus a subsidiary are described based on the Dutch treatment in CITA. Subjects that are discussed are the possibilities for cross-border loss relief and the extent of current taxation of foreign profits. Further, the impact of the principle of equality on these outbound investments is evaluated on the basis of the established theoretical framework of the four different law systems. By the elaboration of outbound investments and the comparison of a head office with a foreign PE to a parent company with a foreign subsidiary and the impact of the principle of equality on this, it will become possible to review whether this is justified in the light of the neutral level playing field.

4.3.1 Cross-border loss relief If a parent company owns a subsidiary abroad, these are two separate corporate entities. Profit is determined at the level of each distinct entity. Therefore if the foreign subsidiary generates a loss, this falls within the tax base of the subsidiary. It is dependent on the profit and loss accounting rules of the state of establishment whether this loss can be offset to previous or future profits.221 Losses of a foreign subsidiary cannot be offset to profits of a Dutch parent company.222 In NL, art. 13 CITA constitutes the participations exemption, through which benefits and expenses on account of the participation are exempt from the tax base of the company that holds the participation and receives these benefits and expenses.223 In art. 13d CITA the only exception with respect to the participation exemption is recorded, by which a parent company can in fact offset losses incurred in the foreign subsidiary, namely a loss incurred with liquidation.224 The ratio behind the Dutch loss winding scheme is that final losses from a subsidiary, that cannot be offset in the state of the subsidiary any more, are eligible in NL at the level of the parent company. According to the sound business practice the total result of an entity should be taxed once during an entity‟s lifetime. Losses on liquidation fall inside the parent company‟s tax base and are therefore allowed to be offset. In this situation double non-taxation or offsetting the loss twice is not possible. This seems in line with Marks & Spencer II, in which the ECJ ruled that it is allowed within the freedom of establishment for

220 E.C.C.M. Kemmeren, Exemption method for PEs and (major) shareholdings best services: the CCCTB and the internal markets concerned, EC Tax Review 2008/3 and E.C.C.M. Kemmeren, Marks & Spencer: balanceren op grenzeloze verliesverrekening, WFR 2006/211. 221 In NL a loss can vertically be accounted with profits in the previous year and nine future years on the basis of art. 20 paragraph 2 CITA. 222 This is recently confirmed by the Dutch Supreme Court in Hoge Raad 2 October 2009, nr. 08/00900 (X BV), V-N 2009/49.22. 223 N.H. de Vries and R.J. de Vries, 2008, section 2.4.0.A.d shows that the ratio behind the participations exemption is ensuring of fiscal neutrality between a subsidiary and a PE by only taxing profits once in CITA. The participations exemption eliminates double economic taxation on foreign profits that are already taxed and distributed to a Dutch entity. Note however that the intended fiscal neutrality is not actually achieved. 224 J.A.G. van der Geld, Fiscale Monografieën 20, De deelnemingsvrijstelling, Deventer: Kluwer 2008, p. 109-162.

4. Permanent establishment versus subsidiary a Member State to exclude losses of the foreign subsidiary from being offset to profits of the domestic parent company, while a State in fact permits this in domestic situations.225 This is however not allowed if the foreign subsidiary has exhausted its possibilities for loss relief in its resident state and if these losses cannot be offset anymore in the latter state.226

In the light of the preliminary ruling, advised by the Dutch Advocate General Wattel, regarding the allowance of a foreign subsidiary within a Dutch fiscal unity, Wattel advises to raise a question about the loss winding scheme.227 This question is about the calculation of the loss on liquidation that is accountable at the level of the parent company. This loss is estimated at the negative difference between the by the parent company sacrificed amount and the received payments due to liquidation of the subsidiary and not estimated at the unaccountable loss at the level of the subsidiary.228 In literature it is pointed out that NL uses the same system for domestic and foreign subsidiaries in that respect, which might form a reason to conclude that this is accepted under European law.229 The Dutch Supreme Court considered this indeed not to be a discrimination and chose to ask only one question regarding the allowance of a cross-border fiscal unity.230 The requested preliminary ruling concerned the allowance of a cross-border fiscal unity, since now only domestic entities and Dutch PEs of foreign entities are allowed to participate in the group taxation system. By excluding foreign entities from the possibility to enter into a fiscal unity, losses of a domestic subsidiary can be offset while losses of a foreign subsidiary cannot be offset within the group. The Dutch Supreme Court has requested a preliminary ruling regarding the compatibility of this impediment on the freedom of establishment in the light of the grounds of justification that are accepted in Marks & Spencer II. These grounds of justification are a balanced distribution of the right to tax, the prevention of double loss relief and the prevention of tax avoidance. In advance of the decision of the ECJ, Advocate General Kokott concluded that the Dutch group taxation system is not contrary to the freedom of establishment.231 The imposed impediment on the freedom of establishment is considered justified on the basis of the balanced distribution of taxing competence of Member States.232 Additionally, in the light of the prevention of tax avoidance, the Advocate General concludes that the exclusion of foreign subsidiaries from entering into a fiscal unity is justified as a means to avoid abuse of cross-border loss relief.233 Since recently the ECJ has passed judgment in X Holding BV234, it became clear that the Court concurs with the justification of the

225 ECJ 13 December 2005, C-446/03 (Marks & Spencer II), point 59. 226 N.H. de Vries and R.J. de Vries, 2008, section 2.4.13.A and J.A.G. van der Geld, 2009, section 10.5.1. 227 Conclusion Advocate General of the Dutch Supreme Court Wattel 4 July 2007, nr. 43848 (X Holding BV), V-N 2007/47.16. 228 N.H. de Vries and R.J. de Vries, 2008, section 2.4.13.A. 229 E.C.C.M. Kemmeren, Marks & Spencer: balanceren op grenzeloze verliesverrekening, WFR 2006/211. 230 Reference for a preliminary ruling from the Dutch Supreme Court, 21 July 2008, C-337/08 (X Holding BV) or Hoge Raad 11 July 2008, nr. 43484, BNB 2008/305c. 231 Conclusion Advocate General of the ECJ Kokott of 19 November 2009, C-337/08 (X Holding BV), V-N 2009/61.19. 232 Criticism on this conclusion consists of the lack of research of other grounds of justification. The prevention of double loss relief in the light of the Dutch measure for catching up for the treatment of PE losses is not compared to the exclusion of losses of foreign subsidiaries. 233 The Advocate General does not research whether this measure is proportionate outside the scope of non-definite losses. 234 ECJ 25 February 2010, C-337/08 (X Holding BV).

4. Permanent establishment versus subsidiary impediment to the balanced distribution of taxing competence of Member States. The ECJ also researched whether the measure is proportionate and suited to reach its goals. In the situation at hand, a domestic subsidiary is compared to a foreign subsidiary. The Court concludes that foreign PEs are not comparable to foreign subsidiaries. As subsidiaries are taxed on the basis of their residency, PEs are taxed on the basis of the allocation of taxing rights in double tax treaties. PEs are taxed on the basis of the income derived in the source state. Therefore the temporary cross-border loss relief possibilities for PEs do not have to be granted to subsidiaries in the same way. NL does not have to allow foreign subsidiaries into the fiscal unity, nor does NL have to expand its method of loss relief of the foreign PE to the foreign subsidiary.

If a head office has a foreign PE, they are one corporate entity together. The profit determination of the PE is described in the previous paragraph. On the basis of the principle of universality, NL levies taxes upon the worldwide income of the Dutch resident entity. In accordance with double tax treaties, the results of the PE are granted a tax relief in the form of a tax exemption with the possibility of offsetting losses with consideration of a recapture measure when later profits arise by decreasing the tax relief for the PE in later years.235 This is in accordance with the principle of domicile. So the head office can offset losses of the foreign PE, but they will be offset to future profits of the PE as far as possible. This system seems in line with the previous discussed case Lidl Belgium.236 Compared the disadvantage that arises in the cross-border situation with a parent company and a subsidiary can be named that the ECJ has accepted this difference in treatment.237 Recently the State secretary of Finance has announced a possible change in the Dutch system of cross-border loss relief for PEs.238 He considers to realize a more territorial approach with respect to PEs, which would mean that foreign losses of a PE would not be included in the Dutch tax base anymore. The system would become one of tax exemptions for both profits and losses of the foreign PE, the temporary cash flow advantage of the possibility to take losses of the foreign PE into account in NL would disappear.239

With respect to current taxation of foreign profits, it can be said that deferring taxation is not a possibility for a parent company that holds a subsidiary abroad, with the exception of the loss winding scheme for a participation.240 If a head office establishes a PE abroad, profit determination of the PE takes place on the basis of the limited distinct and separate entity approach. Profits of the PE are

235 Art. 32 in conjunction with art. 35 Unilateral decree for prevention of double taxation. 236 The system is also in line with other European case law, based on the note to ECJ 23 October 2008, C-157/07 (KR Wanssee), V-N 2008/55.14. 237 E.C.C.M. Kemmeren, Exemption method for PEs and (major) shareholdings best services: the CCCTB and the internal markets concerned, EC Tax Review 2008/3. 238 Letter to the Second Chamber of 5 December 2009, Stand van zaken mogelijke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14. 239 This is an announcement, no or at least only little legal value can be accounted to this document, since it still has to be converted into legislation. 240 Art. 13d CITA.

4. Permanent establishment versus subsidiary allocated to the source state and exempt from the Dutch tax base of the head office. Profits cannot be deferred by the head office. With respect to losses of the PE, which are also allocated to the source state on the basis of double tax treaties, NL grants the possibility to take losses temporarily into account. These losses are offset with profits in later years, so losses also cannot be deferred by the PE. Concluding it can be said that foreign profits are taxed on a current basis.

4.3.2 Evaluation: equality and cross-border loss relief According to the sound business practice the total result of an entity should be taxed once during an entity‟s lifetime. Since in practice it might be difficult to accomplish such taxation, the total result of an entity is divided this into pieces of result each year upon which taxes are levied.241 Profits and losses of an entity should according to the sound business practice be accountable with each other, since they are generated by the same entity. This vertical loss relief is dependent on a country‟s national tax law.242 Horizontal loss relief on the other hand is only possible within the group taxation provision of the fiscal unity.243 One exception in the light of horizontal loss relief, and more specifically cross-border horizontal loss relief is the loss winding scheme for a participation. This prevents losses from completely being excluded from the possibility to be offset anymore.244 The ECJ explicitly obligated all Member States to foresee in a similar measure in Marks & Spencer II245. Furthermore by X Holding BV the ECJ made clear that the domestic group taxation system does not have to be expanded to foreign subsidiaries, since they are incomparable to foreign PEs. Besides that, the correct comparison about domestic versus foreign subsidiaries should be seen in the light of the purpose of the national provision.246 The Court found sufficient grounds of justification that validate the impediment on the freedom of establishment.

Regarding the treatment of loss relief of a domestic head office and foreign PE versus a domestic PE of a foreign entity, NL does not make a distinction. The income of the foreign PE is allocated to the source state based on the principle of domicile, which outranks the principle of universality.247 NL includes the worldwide income of the total entity in the tax base. Subsequently, a tax exemption is granted for the profits attributable to the foreign PE. If losses occur, NL is even more accommodating then necessary. To avoid cash flow disadvantages for the entity, losses immediately decrease the taxable amount of the total entity. The risk NL takes by possibly including losses that shall never be balanced by future profits of the PE, is justified, since the system firstly achieves the prevention of double loss relief. This is confirmed by the ECJ in Lidl Belgium248. The PE is a continuation of the

241 Art. 8 CITA in conjunction with artt. 3.8 and 3.25 PITA. 242 In NL the vertical loss accounting possibility is constituted in art. 20 (2) CITA. 243 Art. 12 Decision Fiscal Unity. 244 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final. 245 ECJ 15 December 2005, C-446/03 (Marks & Spencer II). 246 ECJ 25 February 2010. C-337/08 (X Holding BV), point 21-22. 247 N.H. de Vries and R.J. de Vries, 2008, section 2.4.0.B. 248 ECJ 15 May 2008, C-414/06 (Lidl Belgium).

4. Permanent establishment versus subsidiary head office. Since NL taxes that head office on the basis of the principle of universality, it should take all results of the total entity into account. This is also in line with the equal treatment of domestic and cross-border situations and stimulation of cross-border economic traffic, more specific in the light of the freedom of establishment. The ECJ has confirmed this point of view in AMID.249 The announcement of the State secretary of Finance is not a positive point in that view. Even though it might be recommended to take into account a more territorial system for loss relief of PEs, as is also used for loss relief of subsidiaries, this change would imply a reduction of the freedom of establishment. The ECJ has approved this territorial system of loss relief for PEs with certain additional conditions, so the announced change would be accepted in European law. It would also imply a more equal treatment of loss relief for PEs and subsidiaries, but aside from that it would be a reduction of the freedom of establishment as NL knows it today. Moreover it is debatable whether an equal treatment in this respect is desirable, since the PE is still a part of the entity, while the subsidiary is a distinct entity.

In the light of the principle of equality certain disadvantages arise for the impossibility of loss relief in cross-border situations in comparison with the possibilities for loss relief in domestic situations. An example is the discouragement of foreign investments compared to the encouragement of domestic investments. Companies in larger Member States have an automatic advantage, since their domestic market and therefore possibilities for loss relief are also larger. Furthermore the differences in loss relief have an influence on the choice between a PE or a subsidiary, while this choice should be neutral from a fiscal perspective. All in all it can be said that this is an infringement for the correct working of the internal market.250 But since Member States are sovereign with respect to direct taxes, the ECJ cannot entirely remove this infringement. In addition to this, the Dutch loss winding scheme might entail a discrimination, since the loss relief at the level of the parent company is based on the negative difference between the sacrificed amount and the received payments due to liquidation of the subsidiary. This instead of the unaccountable loss at the level of the subsidiary.251 Since the Dutch Supreme Court did not consider this to be a discrimination, it chose not to raise a question regarding this topic with the ECJ.

With respect to the principle of equality in taxation and current taxation of foreign losses one remark can be made. As described above, it is not possible to defer taxation for both the PE and the subsidiary abroad. The only interesting notion is that losses of the foreign PE that are offset at the level of the head office, are compensated in time when profits arise. This effectively creates a cash

249 ECJ 14 December 2000, C-141/99 (AMID). In this decree it became clear that art. 49 TFEU obstructs a national provision that sees to the restriction of the deductibility of losses if permanent establishments of an entity are established abroad, while these losses would be deductable if the permanent establishments were established in that Member State. 250 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final, par. 1.3. 251 S.A. Stevens, Naar een evenwichtige behandeling van verliezen, WFR 2005/1503.

4. Permanent establishment versus subsidiary flow advantages, since otherwise, if losses are completely excluded from the tax base of the head office, the loss would not decrease the tax base at all. Evidently in NL the losses are recaptured in later profitable years, which balances this method. But in the light of equality this system provides a slight advantage compared to the system that fully excludes losses. Due to the announced change in this regime, this advantage might disappear and treatment of a foreign PE and foreign subsidiary would become more equal with respect to loss relief.252 The State secretary of Finance has stated in this Letter that in the light of European law, definite losses will continue to be relieved. This will then be equal for both the PE and the subsidiary, with the possible exception of the determination of the amount of loss that can be offset.253

4.4. Funding

Funding is an important aspect to take into account when choosing the legal form of a business. In the following part deductibility of funding costs in relation to external parties, both between a parent company and a subsidiary and between a head office and a PE, will be discussed. The difference in treatment of equity and debt will turn out to play a large role herein. Furthermore the qualification and treatment of internal loans between a head office and a PE are elaborated. The impact of the principle of equality on funding is also evaluated, by which the treatment of a foreign subsidiary can be compared to the treatment of a foreign PE.

4.4.1 Funding costs between entities For entities subject to CITA, profit determination rules are recorded in art. 7 up to and including art. 16 CITA. From the total profit of an entity certain amounts are not deductable, this is constituted in those articles. Firstly it is important to emphasize the different treatment of equity versus debt. The remuneration for equity – dividends – are namely not tax deductable, while the remuneration for loans – interest – are. This stimulates companies to finance business with loans.254 In less prosperous economic times the large interest burden then can become a problem for companies with a lot of debt. For fiscal purposes the qualification of debt mostly follows the qualification in civil law.255 In some cases however, in order to prevent abuse, for instance by financing a business through loans that actually qualify as equity, the legislator has come up with several provisions in CITA to exclude interest on loans from being tax deductable. It is beyond the purpose of this paper to describe them all,

252 Letter to the Second Chamber of 5 December 2009, Stand van zaken mogelijke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14. 253 The sacrificed amount on the basis of art. 13d CITA versus the real unaccountable loss of the foreign entity or PE. 254 J.A.G. van der Geld, 2009, p. 74-76. 255 Hoge Raad 27 January 1988, nr. 23919, BNB 1988/217.

4. Permanent establishment versus subsidiary in the following text only several provisions will be named and briefly explained.256 In this section the working of art. 10 (1) (d) and art. 10a CITA are explained. If a parent company takes up a loan from an external party in order to finance a subsidiary, different forms of costs can arise. Firstly, the parent company has to pay interest to the external party for the debt. Secondly, costs can arise for maintaining the financing of the subsidiary, such as administrative and personnel costs at the level of the parent company. Thirdly, costs can arise if a loss on the financing of the subsidiary occurs.

4.4.1.1 Parent company in NL To determine whether the loan is qualified for tax purposes according to the qualification in civil law, it is necessary to determine whether the loan from the external party is taken up under business conditions. If it is not taken up under business conditions, for tax purposes it can possibly be qualified as equity for the parent company through which the interest will be not tax deductable anymore and losses on the loan are not tax deductable anymore based on art. 10 (1) (d) CITA. This is the case if the financing qualifies as a fictitious act, a bottomless pit claim or a participants loan.257 The loan then has the marks of equity to such a degree that for tax purposes it is considered equity.258 These loans are so called hybrid debts.259 Assumed that the external party is in fact an external party and not for instance a shareholder, art. 10 (1) (d) CITA is not applicable and the civil qualification as a loan is followed. This leads to the interest on the loan in principle being tax deductable and losses on the loan being tax deductable on the basis of the principle of prudence. It is however also possible that the loan is qualified as a „10a-loan‟ on the basis of art. 10a CITA.260 In short paragraph 1 of this article constitutes that interest on loans to associated entities is not deductable if the loan is connected to either a profit distribution to an associated entity, a capital deposit in an associated entity or the acquisition or extension of an interest in an associated entity. This article is not applicable if the loan with the connected acts is taken up for mainly business reasons261, or if over the interest at the level of the receiving company a tax over the profit or income is levied that is reasonable compared to Dutch standards.262 Art. 10a CITA exists to counter profit drainage, which companies can achieve by creating debt relations between companies. The interest

256 For an extensive treatment of all named provision is referred to J.N. Bouwman, 2007, p. 95-724 and N.H. de Vries and R.J. de Vries, 2008, section 2. 257 J.N. Bouwman, 2007, p. 120-124. 258 One important decision is Hoge Raad 27 January 1988, nr. 23919, BNB 1988/217 (Unileverarrest). 259 R.P.C.W.M. Brandsma, Fiscale Monografieën 106, Hybride leningen (verstrekt aan lichamen), Deventer: Kluwer 2003, p. 79-130 and J.A.G. van der Geld, (Beperking van) renteaftrek in de vennootschapsbelasting, TFO 2003/167. 260 N.M. Ligthart, De renteaftrekbeperking van art. 10a Wet VPB 1969, TFO 2003/174. 261 Art. 10a (2) CITA. 262 Reasonable compared to Dutch standards means a tax tariff of at least 10%, see B.J. Kiekebeld and J.A.R. van Eijsden, 2009, p. 107.

4. Permanent establishment versus subsidiary costs can be deducted in NL, while the interest revenues are taxed in another country at a lower effective tax rate. In this case art. 10a CITA is firstly only applicable if the external party is established in another country than NL, because otherwise an interest advantage by different effective tax rates cannot be obtained. Since in this case the external party is not an associated entity, the loan can only be qualified as a „10a-loan‟ if the loan in fact, or materially, qualifies as an intercompany loan. This can be the case if for instance companies associated to the parent company vouch for the loan from the external party and this influences the interest rate, the duration of the loan or other criteria that influence the loan.263 If the loan is qualified as a „10a-loan‟, the interest is not tax deductable for the parent company. If the loan does not qualify as a ‟10a-loan‟, the interest is tax deductable for the parent company.

The financing of the subsidiary also has to be qualified according to the provisions in CITA in order to establish whether costs are deductable for the parent company for tax purposes. If the loan is qualified as a „10-1-d-loan‟ and therefore re-qualified as equity for the subsidiary, the payments of the subsidiary to the parent company qualify as dividend distributions instead of interest payments. In conjunction with the participations exemption in art. 13 CITA, these dividend distributions cannot be deducted from the profit of the subsidiary and are exempt from the profit at the level of the parent company. Losses that occur on the loan are not tax deductable due to this re-qualification. If the loan however does not qualify as a „10-1-d-loan‟ and is taken up under business reasons, the next step is to determine whether it is a „10a-loan‟. In order for the parent company and subsidiary to qualify for a „10a-loan‟, the same criteria as in the previous paragraph have to be met. At first the parent company and the subsidiary have to be associated entities, that is if the parent company has at least a one third interest in the subsidiary.264 If the associated entities meet the criteria of the first paragraph of the article, the interest payments are not tax deductable at the level of the subsidiary and the revenues are included in the profit of the parent company. If the criteria of art. 10a CITA are not met or if is proven that the loan with the connected acts is taken up for mainly business reasons, the loan is not qualified as a „10a-loan‟ based on art. 10a (2) CITA. The interest costs then are tax deductable at the level of the subsidiary and the revenues are still included in the profit of the parent company. So the qualification of the financing as a „10a-loan‟ is mostly relevant for the subsidiary.

4.4.1.2 Subsidiary in NL Since the parent company in this case is established outside NL, the treatment of the loan between the parent company and the external party is not relevant for tax deductibility in NL. The

263 E.J.W Heithuis and R.P. van den Dool, Compendium Vennootschapsbelasting, Deventer: Kluwer 2007, p. 116-118. 264 Art. 10a (4) CITA.

4. Permanent establishment versus subsidiary treatment of the financing between the parent company and the subsidiary is however relevant for tax deductibility in NL. The qualification procedure is the same as described in the previous section. In determining tax deductibility of costs incurred by the financing, it is relevant that only costs of the subsidiary can possibly be deducted in NL. The parent company is namely taxed in its state of establishment. Deductibility of payments from the subsidiary to the parent company depends on the qualification of the financing as equity or loan. If according to the procedure the financing is qualified as equity for tax purposes, the payments are not tax deductable for the subsidiary. If the financing is qualified as a loan, the payments are tax deductable for the subsidiary.

4.4.2 Funding costs within entities and internal loans Since the head office and the PE are one legal entity, all costs taken up for financing the PE, are costs of the total entity. To qualify the loan from the external party to the entity has to be determined whether the loan is taken up under business reasons. If it is a loan taken up under business reasons, the interest payments are tax deductable. If it qualifies as a „10-1-d-loan‟, it is considered equity for tax purposes. Furthermore the loan can possibly be qualified as a „10a-loan‟, but only if the loan materially functions as an intercompany loan. The interest then is not tax deductable.

To determine whether the loan from the external party has to be allocated to the head office or to the PE, the before described criterion subservience is leading.265 According to the profit determination rules of the limited distinct and separate entity approach, the loan and accompanying interest payments are allocated to the PE if the loan is subservient to the conduct of business of the PE.266 More specifically the Dutch Supreme Court has described that loans from external parties can only be attributed to the PE if these debts are concluded specifically in benefit of the PE.267 Hereby it is of concern that the loan is accounted to the part of the entity that bears the remunerations for the loan and not to the part of the entity that ensures the financing activities for the loan itself.268 If in the above situation the loan and accompanying interest payments are attributed to the PE, this decreases the profit of the PE. The interest payments first decrease the total profit of the entity as a whole and subsequently these payments are attributed to the PE. NL grants a tax exemption for the foreign PE‟s profit, so the head office cannot take the costs for the loan into account if the loan is

265 As already confirmed a long time ago by the Dutch Supreme Court in Hoge Raad 18 November 1931, B. 5085. The OECD also handles the criterion of subservience, see OECD, Report on the Attribution of Profits to Permanent Establishment, OECD, Paris 2008, p. 15-16 and p. 49. See also the Commentary on art. 7 OECD-MC, paragraph 3, nr. 43 and 51. 266 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 1), WFR 2003/1965 and E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 2), WFR 2003/2005. 267 Hoge Raad 7 May 1997, BNB 1997/263. 268 Hoge Raad 28 April 1954, BNB 1954/186, ad Subsidiair.

4. Permanent establishment versus subsidiary accounted to the PE. If the loan and accompanying interest payments are allocated to the head office, the remunerations are tax deductable for the head office. In the situation with a Dutch PE of a foreign entity, as in the picture on the right, the allocation of the loan and interest payments works out the same. If the loan is subservient to the conduct of the business of the PE, the remunerations for the loan decrease the profit allocated to the Dutch PE. The head office cannot take the costs for the loan into account. If the loan is attributed to the head office, the loan does not influence the profit determination of the PE.

For tax purposes the treatment of internal loans between the head office and the PE is also relevant. In contrary to loans from parent companies to subsidiaries, where these loans are allocated on the basis of the independency of both entities, this is slightly nuanced for loans from head offices to PEs. In NL, loans between head offices and PEs are in principle not accepted for tax purposes.269 The vision is that an entity cannot own a debt to itself, whereas the PE is merely a part of the total entity. If the head office loans money to the PE, it has to be seen as equity of the PE in the line of the limited and distinct separate entity approach. Internal interest payments are also not included in the profit determination of a PE.270 The economic reality of the money loaned to the PE is that is serves as equity for the PE. Then it is unrealistic to label this money as debt.271 The Dutch Supreme Court has worded this explicitly, with the exception for loans of which the business reasons cannot be doubted.272 One exception to the fiscal exclusion of internal loans and interest payments are currency exchange results.273 The Dutch Supreme Court considered that in the situation with an internal loan no actual legal debt exists, but for the profit determination of the PE as a limited and distinct separate entity the currency exchange results due to that loan need to be taken into account. This system seems EU-proof, since in the adverse situation in Deutsche Shell GmbH the ECJ ruled that a Member State has to take currency exchange losses due to the repatriation of a start-up capital for a foreign PE to the resident entity into account.274 Apart from that, the OECD seems to depart somewhat of this view. In order to completely follow through the functionally separate entity approach, internal interest in some cases can be recognized for tax purposes.275 It is named that this view is however limited to the

269 This is states by the Dutch Supreme Court in several decisions, among which Hoge Raad 28 April 1954, BNB 1954/186 and Hoge Raad 7 May 1963, BNB 1997/263. See also E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 2), WFR 2003/2005. 270 N.M. van der Wal, Vaste inrichtingen en het gemeenschapsrecht: enkele kwetsbare onderdelen van de Nederlandse regelgeving, WFR 2009/436. 271 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 2), WFR 2003/2005. 272 Hoge Raad 25 November 2005, BNB 2007/117. 273 Hoge Raad 28 April 1954, BNB 1954/186 and Hoge Raad 8 November 1989, BNB 1990/36. 274 ECJ 28 February 2008, C-293/06 (Deutsche Shell GmbH). In addition to that it was also not permitted to allow a currency loss to be deducted as operating expenditure in respect of an undertaking with a permanent establishment in another Member State only insofar as the permanent establishment did not make any tax free profits. 275 OECD, Report on the Attribution of Profits to Permanent Establishment, OECD, Paris 2008, p. 49.

4. Permanent establishment versus subsidiary treasury function of non-financial businesses.276 It is debatable as to how far Member States will and should join this approach. For domestic entities with a foreign PE, the system of excluding internal loans and interest payments is an advantage. The tax exemption namely is higher, because NL does not take the interest payments into account that would otherwise decrease the profit of the PE and therefore decrease the tax exemption. For foreign entities with a Dutch PE this is a disadvantage, since the interest payments do not decrease the taxable profit of the PE and therefore more taxes can be levied upon the Dutch PE.

4.4.3 Evaluation: equality, funding costs and internal loans The principle of equality has an impact on both funding costs and internal loans. With respect to funding costs the situation between a parent company and a subsidiary versus a head office and a PE are compared. The treatment of a loan from an external party is equal for both situations. At first has to be determined whether the civil qualification as a loan is followed for tax purposes. As described, under certain conditions the loan is qualified as equity for either the parent company or the entity with the head office and the PE. The interest payments then are not tax deductable. One difference between a parent company and a subsidiary versus a head office and a PE is that in the first situation the loan is attributed to the entities on the basis of their independency, while in the second situation the loan is only attributed to the PE if it is subservient to its business. This is due to the fact that the PE is not a legal independent entity, it is merely a fiscal concept.

Loans between a parent company and a subsidiary are qualified in the same way as loans between external parties, by the same procedure as described above. Internal loans between a head office and a PE are treated differently. Internal loans and interest payments are in NL in principle not taken into account for tax purposes, since an entity cannot establish a debt to itself. One exception to this that NL takes currency exchange results from a loan between a head office and a PE into account. In literature is pointed out that with respect to the different treatment of loans to subsidiaries versus loans to PEs several visions exist. The Dutch Supreme Court carries out the vision that internal debt does not have to be acknowledged.277 For this view that values the economical reality of money substantial support exists.278 However, the arm‟s length principle is also quoted in literature as the justification of the allowance of taking internal loans and interest payments into account.279 This vision compares the situation of a head office and a PE to the situation with a parent company and a subsidiary, in which profit determination for all entities should be established in the most possible

276 N.M. van der Wal, Vaste inrichtingen en het gemeenschapsrecht: enkele kwetsbare onderdelen van de Nederlandse regelgeving, WFR 2009/436. 277 Hoge Raad 7 May 1997, BNB 1997/263 and BNB 1997/264. 278 E.C.C.M. Kemmeren, Vermogensetikettering bij een vaste inrichting (deel 2), WFR 2003/2005 and footnotes 64 and 65 with the article. 279 F.C. de Hosson, Het onderscheid vaste inrichting – dochtervenootschap bezien vanuit gemeenschappelijk perspectief, WFR 2003/1581 and D. Juch, Internationaal fiscaal (verdragen)recht, MBB 1999/115.

4. Permanent establishment versus subsidiary economic independent way. More specifically, a subsidiary and a PE in the same state may not be restricted on the basis of the freedom of establishment.280 If the PE has to be granted equal treatment compared to the subsidiary, on the basis of the functionally separate entity approach the internal loans do have to be taken into account. Therefore it might be concluded that a more equal treatment of loans between a parent company and a subsidiary versus loans between a head office and a PE could possibly be realized in the future. This would also be in line with the described view of the OECD. A comment to support this observation is that the ECJ passed a judgement that possibly can be applied to this situation, namely CLT-UFA.281 With respect to this situation the ECJ considers in CLT- UFA that the only relevant difference between a PE and a subsidiary with a profit distribution to a head office respectively a parent company, is that a subsidiary has to make a formal decision to do so, while the PE does not. This difference was not essential to justify different treatment. With respect to the present issue, a PE in comparison with a subsidiary regarding the treatment of internal loans, can be concluded that a subsidiary has a legal contract for the loan, while the PE does not. Since this is the only difference between these two legal forms regarding the internal loan, it is arguable whether the different treatment between them is justified based on the considerations in CLT-UFA.282

Another decision of the ECJ however points in a different direction. With respect to the situation of a foreign subsidiary and a foreign PE, European law does not obligate an equal treatment, as is confirmed by the ECJ in X Holding BV.283 Since the foreign subsidiary is a legal independent person, it is unlimited liable to tax in its resident state. The PE is merely an extension of the head office and therefore it is firstly liable to tax in the resident state of the head office. This difference can be a justification of not seeing the internal loan between a head office and a PE as an independent legal transaction, since it simply is not an independent legal transaction. The Dutch Supreme Court seems to support this vision.284 The Court states that an essential difference exists between a subsidiary and a PE and holds this conclusion in line with European law.285 In my opinion the civil difference between a subsidiary and a PE can be seen as a justification of the different treatment regarding acceptance of interest payments for internal loans. Even though great similarity between the PE and the subsidiary exist, these legal forms are not identical and therefore not automatically entitled to identical treatment. The economic reality of internal loans is of great importance for the distinguished treatment.

280 ECJ 21 September 1999, C-307/97 (Saint-Gobain). 281 ECJ 23 February 2006, C-253/03 (CLT-UFA). In CLT-UFA was decided that a national provision that taxes profits of a foreign permanent establishment with a higher tax rate than the tax rate for profits of a foreign subsidiary, if this subsidiary distributes its profit completely to the parent company, is contrary to the freedom of establishment. Moreover, the ECJ judges that this difference in tariff is an impediment to the freedom of the choice of the legal form fitting for cross-border business activities. 282 N.M. van der Wal, Vaste inrichtingen en het gemeenschapsrecht: enkele kwetsbare onderdelen van de Nederlandse regelgeving, WFR 2009/436. 283 ECJ 25 February 2010, C-337/08 (X Holding BV). 284 Hoge Raad 8 August 2008, BNB 2008/255. 285 N.M. van der Wal, Vaste inrichtingen en het gemeenschapsrecht: enkele kwetsbare onderdelen van de Nederlandse regelgeving, WFR 2009/436, even though the author does not concur with this vision.

4. Permanent establishment versus subsidiary

Regarding the treatment of loans between parent companies and subsidiaries versus head offices and PEs can generally be said that the fact that the PE is not a legal distinct entity creates an inequality. One specific exception to the fiscal exclusion of loans between head offices and PEs is the currency exchange results on these internal loans. This might possibly be an inequality in which PEs are treated better than subsidiaries. A subsidiary can namely not take these currency results into account.286 This can be defended in the light of the purpose of the participations exemption, ensuring that profits and losses are only taken into account once.287 With respect to currency exchange results however, can be stated that the profit of the foreign subsidiary is determined in that other currency. Currency exchange results between the Dutch currency and the foreign currency are not taken into account when determining that profit. The participations exemption then cannot serve as a justification for not taking into account these currency exchange results.288 Deutsche Shell GmbH in combination with two decisions of the Dutch Supreme Court might in this perspective lead to a different conclusion regarding the possibility of taking currency exchange results into account for participations.289 The ECJ ruled in Deutsche Shell GmbH that a Member State has to take currency exchange losses due to repatriation of a start-up capital for a foreign PE into account. Three elements are important in this case, namely that losses have actually economically occurred, losses cannot be offset in the other state and losses are definite.290 The Dutch Supreme Court ruled that the exclusion of currency exchange losses, that cannot be taken into account in the state of establishment, is not accepted.291 NL should take the currency exchange loss on a foreign subsidiary into account when it has actually economically occurred.292

Furthermore the different treatment of loans between parent companies and subsidiaries versus head offices and PEs comes forth out of their different legal distinction. As already described, European law has so far not yet proven to be a direct reason to eliminate this inequality, but might become so in the future.

4.5 Conclusion on permanent establishment versus subsidiary

A PE as an extension of the general entity versus a subsidiary as a legal distinct entity are not comparable in NL. This extends to eligibility to treaty benefits. A subsidiary is considered to be a resident and therefore has access to double tax treaties, whereas a PE is not considered a resident and

286 Hoge Raad 9 June 1982, nr. 21142, BNB 1982/230. 287 J.A.G. van der Geld, 2009, Chapter 6. 288 S.C.W. Douma, Valutaverlies op deelneming aftrekbaar!, NTFR 2008/2327. 289 S.C.W. Douma, Valutaverlies op deelneming: aftrekbaar!, NTFR 2008/2327. Referred is to ECJ 28 February 2008, C-293/06 (Deutsche Shell GmbH), Hoge Raad 26 September 2008, nr. 43338, BNB 2009/23 and Hoge Raad 26 September 2008, nr. 43339, BNB 2009/24. 290 B.J. Kiekebeld and J.A.R. van Eijsden, 2009, p. 60. 291 Hoge Raad 26 September 2008, nr. 43338, BNB 2009/23. 292 S.C.W. Douma states that this is when a participation is sold, but also during the period of ownership of the participation, based on the sound business practice. See S.C.W. Douma, Valutaverlies op deelneming aftrekbaar!, NTFR 2008/2327.

4. Permanent establishment versus subsidiary cannot call upon treaty benefits. Since the ECJ ruled Saint-Gobain293, PEs became eligible to treaty benefits through the foreign entity that they are part of, regarding the same rights to treaty advantages as are granted to residents as long is the object of taxation is taxed identically for both taxpayers without the residency being of interest. NL has expanded this limited treaty access for PEs to non-EU countries that have concluded a double tax treaty with a non-discrimination clause with NL. Profit determination of a subsidiary as a distinct legal entity is based on art. 2 in conjunction with 7 CITA, whereas the profit determination of a PE in NL is determined on the basis of art. 3 in conjunction with 17 (3) CITA. Determination of the taxable profit of a PE is based on the limited distinct and separate entity approach, comparable to the „functionally separate entity‟ approach used by the OECD. Assets or liabilities and the profits or losses that come from those, are attributed to the PE on the basis of the criterion of subservience. NL firstly establishes the total tax base of the entire entity, including that of the PE, after which the profits attributable to the PE are exempt from taxes. Losses of the PE can temporarily be offset, due to the exemption method the NL uses for granting tax reliefs to PEs. Tax rates are for both legal forms 20% up till 25,5%. Under specific conditions it is possible for a Dutch PE of a foreign entity to enter into the group taxation system. A fiscal unity provides tax consolidation for the group and pooling profits and losses within the group is a possibility. In the light of the principle of equality can be mentioned that NL does not levy an additional tax, such as a branch profit tax, on profit repatriations from a PE to a head office. This is due to the fact that all results of the PE are only included in the tax base of the total entity once and the PE cannot make profit distributions. Furthermore is described that it might be possible to offset losses of the PE twice, when recapture measures cannot be applied anymore. The ECJ has explicitly accepted this exemption method in Lidl Belgium294 and it can therefore be considered to be in line with European law. This is unequal compared to the loss winding scheme applicable to losses incurred with liquidation, wherein losses can only be offset once.

With respect to cross-border loss relief can be said that this is generally not possible between separate entities. One exception however are losses incurred on liquidation, as far as they cannot be offset in the resident state of the subsidiary.295 In this system is assured that losses are only offset once. Considering the fact that foreign subsidiaries are not allowed to participate into the Dutch group

293 ECJ 21 September 1999, C-307/97 (Saint-Gobain). 294 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 295 This measure is considered to be in line with ECJ 13 December 2005, C-446/03 (Marks & Spencer II).

4. Permanent establishment versus subsidiary taxation system and are therefore restricted to offset their losses in a group in comparison with PEs of foreign entities, a preliminary ruling was requested by the Dutch Supreme Court. Judgment was passed in X Holding BV296, in which the ECJ made clear that the impediment to the freedom of establishment by this restriction is justified on the basis of the balanced distribution of taxation rights between Member States and the avoidance of abuse of loss relief possibilities and additionally that foreign PEs cannot be compared to foreign subsidiaries. NL does not have to allow foreign subsidiaries into the fiscal unity, nor does it have to expand its method of loss relief for the foreign PE to the foreign subsidiary. The announcement of the State secretary of Finance to create a more territorial system of loss relief for PEs, as is also used for loss relief for subsidiaries, would imply a reduction of the freedom of establishment. It is namely debatable whether an equal treatment of foreign subsidiaries and foreign PEs is desirable, since the PE is a part of the total entity, while the subsidiary is a distinct legal entity. With respect to current taxation of foreign profits can be said that deferring taxation abroad is generally not possible. One interesting detail is that the Dutch exemption method allows the domestically offsetting of losses of the foreign PE which constitutes a cash flow advantage. This is however usually balanced by the recapture measures in later years.

With respect to funding, the different treatment of equity versus debt stimulates companies to finance with debt, while dividends are not deductable whereas interest payments generally are. This led to the creation of several anti-abuse measures that restrict interest deductibility for tax purposes. The most important measures are the restrictions regarding hybrid debts297 and the restrictions on connected loans298. In situations of financing between entities, first the presence of a hybrid debt must be checked, after which the presence of a connected loan must be checked. In the situation of financing within entities, an extra check is needed regarding the attribution of the internal loan. If the debt is re-qualified as equity for tax purposes, interest costs cannot be deducted. Apart from that, attribution of a loan is either based on the legal independency of a subsidiary or on the subservience of the loan to the PE on the basis of the limited and distinct separate entity approach. Internal loans and accordingly interest payments between a head office and a PE are not visible in tax law, since an entity cannot own a debt to itself. Currency exchange results on these interest loans can however be taken into account. In literature a discussion as to whether a more equal treatment of internal loans between entities in comparison as to within entities is needed has taken place.

296 ECJ 25 February 2010, C-337/08 (X Holding BV). 297 Art. 10 (1) (d) CITA. 298 Art. 10a CITA.

4. Permanent establishment versus subsidiary

In general it can be concluded that the approach of how a PE and a subsidiary relate to each other is decisive as to how equally these legal forms deserve to be treated. Civil law differences imply unequal treatment. Fiscal law similarities however, especially as regards profit determination, plead for a more equal treatment. It is hard to draw a clear line as to up till which level these legal forms need to be treated alike. Reviewing this entire chapter in the light of the desired neutral level playing field different conclusions can be applied. As for inbound situations – the perspective of the host state – a large equality has developed between PEs and subsidiaries, partly on the basis of European case law. This can however not be said for outbound situations. In the perspective of the home state a larger amount of inequalities between treatment of PEs versus subsidiaries seems to be accepted, mostly on the basis of European case law again. With respect to equal treatment of the legal forms in the field of funding, no ambiguous conclusion can be given. A broad discussion in literature and varying decisions in jurisprudence still gives room to interpretation.

So in general the neutral level playing field as regards permanent establishments versus subsidiaries is not reached yet. In Chapter 6 will therefore review the topics cross-border loss relief and group taxation in more detail. A legal comparison, an evaluation of the different methods and systems in the light of the principle of equality in taxation, especially in European law, will give guidance as to how the neutral level playing field should best be filled-in concerning these specific topics to contribute to more neutrality in the choice of the legal form.

5. Qualification methods for foreign entities

5.1 Introduction

In the description on the qualification of entities several issues came across. Hybrid entities can be qualified as corporate in one state and as non-corporate in the other state. This can lead to double (non-)taxation. The differing methods countries use to deal with the selected topic of the qualification of foreign entities will be illustrated by means of a legal comparison of the EUCOTAX Countries. Firstly a description of the legal comparison of qualification methods for foreign entities will be given, after which these methods will generally be discussed in the light of the principle of equality in taxation. Then the scope of possible influence of European law on hybrid entities is elucidated. As regards European law will be reviewed with respect to company law whether possibly the incorporation principle or the real seat principle has preference. This is relevant since several countries use company law to a certain extent to qualify foreign entities for domestic tax purposes. After this section will be focussed on which general principles are accepted in European law as a basis for taxation, before proceeding to a description of the large autonomy for Member States to qualify entities for tax purposes, the possible legislative basis for enforcing Member States to negotiate mutual recognition of entities in combination with the freedom of establishment, the more general concept of mutual recognition and the possibility to use already constituted secondary legislation to solve the hybrid entity problem to some extent. Following to that, a more international possible solution for problems regarding double (non-)taxation of hybrid entities will be entailed, specifically in the light of tax treaties. By this stage will become clear that tax treaties mainly focus on eliminating double taxation or double non-taxation and are therefore not fit to solve the basis of the qualification differences for entities, the different qualification methods. After having discussed varying solutions for problems due to different qualification methods regarding hybrid entities, a discussion of the most desired solution to reach the level playing field with respect to legal forms of businesses will follow. At last, these topics will be summarized in a conclusion.

5.2 Qualification of foreign entities

In drawing up the qualification methods for both domestic and foreign entities, distinctions between methods for domestic versus foreign entities appeared for all countries. Moreover, these distinctions even expand to – slightly – differing qualification methods for foreign entities in almost all countries. The leading principles in classifying entities as either corporate or non-corporate are however generally the same for all entities, namely the possession of legal personality, the structure of

5. Qualification methods for foreign entities the entity and the liability of the shareholders or partners. Next, the various classification methods for foreign entities for tax purposes will be discussed, before reviewing them in the light of the principle of equality. In that respect the issues regarding hybrid entities, related to possible solutions will be discussed.

5.2.1 Qualification methods – a legal comparison No general similarity can be found between all the systems of qualification of foreign entities as corporate or non-corporate entities for tax purposes. A number of similarities is however present. First, Austria and the United States (USA) partly qualify several entities conform a preset list. The latter knows a per se corporations list, besides mandatory corporate personality for entities with only limited liability owners. Austria uses the list recorded in the Parent-Subsidiary Directive.299 In addition to these lists, the USA uses Qualification of foreign entities Austria List from Parent-Subsidiary Directive and for entities not on the list the most accommodating approach in characteristics comparison to Austrian standards Belgium 1. Lex societatis test (corporate law), 2. Outbound: Lex Fori test (legal the form of an elective system for all criteria compared to Belgian law) & Inbound: comparability test (to Belgian entities) remaining entities.300 France Characteristics comparison to French non-corporate entity, otherwise Second, some kind of taxed in CIT Germany Characteristics comparison to German standards comparability or resemblance test to Italy Principle of typicality and other foreign entities are considered non- transparent and subject to CIT classify foreign entities is applied by a NL Characteristics comparison to Dutch standards Poland Qualification under foreign law and additional mirror image rule: reasonable number of countries. Such foreign partnership treated as corporation if it is taxable entity (for worldwide income) and legal person in resident state an approach is utilized by France, Sweden Definition of foreign legal person with criteria, otherwise considered Germany, Italy and the Netherlands, in non-corporate UK 1. Foreign commercial law in combination with comparison to UK which the foreign entities are legal form, 2. Several factor test for characteristics if no comparable UK legal form evaluated by taking into account the USA 1. Per se corporations and companies with all limited liability owners are corporations, 2. Elective system for all other entities domestic legal standards that define a legal person.301 Austria uses a similar comparison approach in situations where an entity is not included on the list in the Parent-Subsidiary Directive. In addition to the characteristics comparison, France and Italy qualify all foreign entities that cannot be qualified by this comparison test as corporate entities. Furthermore Belgium and the United Kingdom (UK) also apply this method supplementary to other methods. Third, foreign law can also provide guidance for qualification for domestic tax purposes. Belgium uses the foreign corporate law302, whereas the UK uses foreign commercial law for classification. The

299 Appendix 2 to the Austrian Einkommensteuergesetz (Income Tax Act), following the Parent-Subsidiary Directive, art. 2 and appendix (90/435/EEG). 300 Regulations § 301.7701-1 through -3 (USA). 301 According to the OECD this is a common known method for classifying entities. OECD, The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, p. 9. 302 Art. 110 of the Belgian code on international private law and the case Brussel 4th of June 1974, J.D.F. 1975, 82. In this case became clear that the so-called Lex Societatis test is only based on foreign corporate law and does not adhere to fiscal treatment or tax law in that country.

5. Qualification methods for foreign entities latter however only makes use of this method in combination with a comparison to legal forms in the UK. Fourth, two individual methods exist. Sweden constructed a definition of a foreign legal person and excludes all other foreign entities from having corporate personality. And at last Poland accepts the qualification under foreign law, supplemented with the so-called "mirror image" rule for specific partnerships: partnerships are qualified as corporate entities if they are liable to tax for their worldwide income in their resident state and considered to be a legal person there.303

So, not one single line can be defined concerning these methods, but the preset list and especially the comparison test seem recurrent present. Although nuances between the exact use of these methods cause slight differences between the countries, several countries seem to support these systems.

5.2.2 Qualification methods for tax purposes and equality Taking this legal comparison into account, the impact of the principle of equality in taxation on this subject is now generally discussed, before entering into details about specific solutions concerning qualification problems. In general, consensus consists about the principles for classifying entities as either corporate or non-corporate and a rough line regarding the methods for qualification of foreign entities for tax purposes is established. Furthermore no country distinguishes between qualification methods for specific countries, which complies with the most-favourable nation treatment rule.

Several aspects of the studied qualification methods should be revised in the light of the principle of equality. For instance the qualification system used by France and Italy if an entity cannot be qualified by the characteristics comparison. Both countries implement a somewhat rigorous approach, since all entities outside the comparison are qualified as corporate entities and deemed to be subject to corporate income tax. Entities within the scope of the characteristics comparison will include most standard legal forms. However, entities outside that scope will be hybrid entities, entities that have marks of both corporate and non-corporate entities. Classifying them all as corporate entities can lead to classification differences in numerous situations. Even though the comparison test as used by several countries withholds a comparable system for qualification, this system is based upon each countries domestic law. The most common legal forms will very likely be qualified alike in both states. This is for example reflected by the list of corporate entities recorded in the Parent-Subsidiary Directive, upon which 27 European countries have agreed.304 The Parent-Subsidiary Directive is however meant for neutralizing the fiscal disadvantages for cross-border parents and subsidiaries compared to national parents and subsidiaries by levying no

303 http://online2.ibfd.org/gii/, under point 1.1.4. 304 Parent-Subsidiary Directive, art. 2 and appendix (90/435/EEG).

5. Qualification methods for foreign entities taxation upon distributed profits in the state of the parent company or granting tax relief in the form of the credit method.305 The Directive is not meant for qualifying entities. Notwithstanding the purpose of the Directive, consensus upon the qualification of a lot of entities for tax purposes is already reached. Therefore it can be considered highly in compliance with European law to follow this list in qualifying foreign entities for domestic tax purposes. As described in the legal comparison, Austria is still the only state that uses this preset list for classification of foreign entities for tax purposes. Apart from the list, less common legal forms can be qualified dissimilarly by a comparability test.306 This shows that despite the fact that a number of states use the same qualification method, namely the comparability method, this does not guarantee identical qualification of foreign entities. Each state can decide which criteria are decisive for attributing legal personality and if emphasis is placed upon differing criteria, this might lead to different qualifications of one entity in two or more states. A solution might possibly be found in following the entity qualification in foreign law. This approach is already used in a nuanced form by two states according to the legal comparison. In the light of the described broad autonomy for states in classification, this will however not become enforceable by law in my opinion.

5.3 Hybrid entities and European law

Within European law, tax law is not the only law jurisdiction that is relevant for the qualification of entities. Several states classify entities in their civil or corporate law, which classifications are subsequently used by other states to qualify entities for their domestic tax purposes. Classification according to either the incorporation principle or the real seat principle can also give rise to classification conflicts between states. A description of the applied principles in the EUCOTAX Countries and the consequences of these principles in European case law perspective is given. Qualification problems for tax purposes can roughly be divided in two concepts. The first concept concerns the qualification of entities as taxable subjects. States can classify either the entity as a taxable subject, or disregard the entity and consider the partners as the taxable subjects on the basis of the principle of fiscal transparency. This extends to the determination of treaty eligibility of either the entity or the partners. The second concept concerns the allocation of income of entities, or in other words the taxable object. The relevance of these concepts is mainly the fact that the classification of a taxable subject is based upon domestic law of a state, which is then followed by the other state to

305 Parent-Subsidiary Directive, Preamble to the 1990 text, paragraph 3 and 4. 306 OECD, The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, p. 10.

5. Qualification methods for foreign entities determine the allocation of the taxable object.307 Whereas treaties do not see to solve classification conflicts of taxable subjects in general, treaties do attempt to resolve income allocation conflicts.308 Particularly relevant is the fact that European law does not extend to fiscal disparities between national legislation of Member States. This covers the justification for the different qualification methods used for classification of foreign entities. Autonomous qualification methods usually do not make distinctions on the basis of nationality, since all foreign entities are qualified according to the same scheme.309 As long as no European law is created that sees to a uniform method, the influence of European law on this area is restricted to the treaty freedoms. Therefore in the following section will also be explained to what extent European legislation and case law have an influence on classification conflicts of both subjective and objective qualification.

5.3.1 Incorporation versus real seat principle States autonomously classify entities for both tax purposes as for non-tax purposes and no general definition of a corporate or non-corporate entity exists. Several states classify a number of entities in their domestic civil or corporate law, but this does not extend to foreign entities. If an entity conducts business in more than one jurisdiction, classification conflicts between the both civil or corporate laws may arise. States generally adhere either the incorporation or the real seat principle. EUCOTAX Countries that use the incorporation principle are France, Germany310, NL, Sweden311, UK and USA312 as to Austria, Belgium313, Italy314 and Poland315 follow the real seat doctrine.316 Supporters of the incorporation doctrine state that this principle ensures an efficient working of the internal market, since entities can freely transfer seats without ceasing to exist and needing to be reinstituted in the new resident state.317 Therefore the continuity of the entity is safeguarded.318 A disadvantage is however the fact that without additional legislation, abuse is possible by incorporating the entity in the

307 OECD-MC, Commentary to art. 1, paragraph 9.2 and paragraph 22.1. See also J. Wheeler, The attribution of income to a person for tax treaty purposes, IBFD, Bulletin for International Fiscal Documentation, November 2005, paragraph 4.2. 308 J. Wheeler, The attribution of income to a person for tax treaty purposes, IBFD, Bulletin for International Fiscal Documentation, November 2005. 309 G.K. Fibbe, 2009, p. 151. 310 D. Schaber, EUCOTAX 2010 Paper Germany, The principle of equality in taxation, p. 10-11, with reference to Schirmer in M. Preißer and A. Pung, Die Besteuerung der Personen- und Kapitalgesellschaften – Kommentar, Stuttgart: HDS-Verlag: 2009, p. 748. It should be noted however that Germany only recently became an adherent of the incorporation principle due to European case law that ruled in disadvantage of the real seat principle. 311 Y. Rhenman, EUCOTAX 2010 Paper Sweden, Equality and the choice of the legal form of a business, p. 7, with reference to chapter 6, section 3 of the Swedish inkomstskattelagen (Income Tax Act) 1999:1229. 312 Y.B. Bozkurt, EUCOTAX 2010 Paper USA, Equality and the choice of the legal form of a business, p. 8, with reference to Internal Revenue Code § 7701(a)(4). 313 J. Engelen, EUCOTAX 2010 Paper Belgium, The principle of equality in taxation and the choice of the legal form of a business, p. 9, with reference to P. Beghin, K. Flamant and I. van de Woesteyne, Handboek vennootschapsbelasting 2007-2008, Antwerpen: Intersentia 2007, p. 7. 314 R. Natale, EUCOTAX 2010 Paper Italy, Equality and the choice of the legal form of a business, p. 15, with reference to art. 25 of L. n. 218/1995 (Reform of private international law) and Calo', Consiglio Nazionale Del Notariato, Trasferimento all'estero della sede sociale, studio n. 3310, http://www.notariato.it/Notariato/StaticFiles/Studi_e_approfondimenti/3310.pdf. 315 M. Stokowska, EUCOTAX 2010 Paper Poland, The principle of equality in taxation, p. 2, to be found in art. 9.2 of the International Private Law. 316 With respect to the EUCOTAX Countries, except NL, for which this was not included in the paper, the following guide was used: Ernst & Young, The 2008 Worldwide Corporate Tax Guide, 2008. This concerned Austria, France and the UK. 317 J.W. Bellingwout, Zetelverplaatsing van rechtspersonen, Deventer: Kluwer 1996, p. 19. 318 E. Werlauff, The main seat criterion in a new disguise – An acceptable version of the Classig man seat criterion?, European Business Law Review 2001, nr. 2.

5. Qualification methods for foreign entities most favourable state. The adherents of the real seat principle allege that this doctrine was created to prevent the inflow of foreign entities and to effectively monitor entities. Above that, abuse by incorporating the entity in the state with the most advantageous legislation is not possible by the latter principle.319 A disadvantage of this principle is however that the continuity of the entity is at stake when relocating the seat. Regardless of which method is more considerable than the other, these methods can cause conflicts when two states adhere a different principle. Merely one example is when an entity is incorporated in a state that follows the incorporation principle, while the place of effective management or the real seat is established in a state that follows the real seat principle.320 Since no multilateral agreements on avoiding such conflicts have been made, this is dependent on unilateral or bilateral solutions. It can be considered what the influence of European law is on these conflicts and these different principles.

The ECJ has ruled a number of cases regarding these principles and the freedom of establishment. Since 1988 when in Daily Mail321 a large freedom was granted to Member States, which did not have to allow a company to transfer its seat to another state on the basis of the freedom of establishment, case law shows that the environment has changed. It seems that the ECJ in later years attaches less value to the fact that no harmonization of company law is realized within the internal market. This is explicitly stated in the ruling Centros, which made clear that the freedom of establishment entails the right to incorporate an entity in any Member State without impediments.322 So, while in 1988 the real seat doctrine was more or less accepted in European law, this slightly changed when the ECJ ruled Centros.323 By now it has become clear that the real seat principle is still accepted under European law, albeit with certain restrictions. The departure country is allowed to make requirements regarding a domestic entity to maintain this qualification, but dissolution and liquidation may not be demanded when a transfer of the real seat is accompanied by a conversion into an entity by the domestic law of the receiving state. The ECJ stated this in Cartesio.324 Therefore the freedom of establishment is fully applicable to entities. If an entity transfers its seat to another state, additional requirements and consequences are exclusively controlled by the state in which the entity was established.325

319 E. Werlauff, The main seat criterion in a new disguise – An acceptable version of the Classig man seat criterion?, European Business Law Review 2001, nr. 2. 320 A somewhat extended example can be if the entity transfers its place of effective management from a real seat state to an incorporation state. Then the entity would not be acknowledged in both states. Since the topic of transferring seats is too broad for this thesis, this will not be further treated. 321 ECJ 27 September 1998, 81/87 (Daily Mail). 322 ECJ 9 March 1999, C-212/97 (Centros). In point 28 is referred to the lack of importance of the non-harmonized legislation with respect to company law. In general the ECJ ruled in Centros that the right to free establishment in the European Union may not be impeded by additional demands concerning the establishment in a certain Member State. It is however allowed to establish anti abuse measures in order to prevent unjustified abuse of this freedom. 323 This was affirmed in ECJ 5 November 2002, C-208/00 (Überseering). 324 ECJ 16 December 2008, C-210/06 (Cartesio), point 111-113. 325 L.F.A. Steffens, Strijd tussen de incorporatieleer en de leer van de werkelijke zetel, De vrijheid van vestiging in Europa volgens het Hof van Justitie, TvOB 2004/1.

5. Qualification methods for foreign entities

So from case law it appears that the incorporation doctrine has a slight preference over the real seat doctrine, but both methods are still accepted under European law. It can however be advised in order to prevent taxation conflicts, to internationally adhere only one principle. If all states would apply the incorporation principle, it will no longer be possible for an entity not to be acknowledged in any state, as well as the international movement will be stimulated. Furthermore no additional administrative burden occurs if the seat is transferred to another state. Nevertheless the incorporation doctrine will impose new issues regarding for instance exit taxes and double taxation when an entity is incorporated in more than one state. Both the incorporation and the real seat doctrine mostly concern company law. If for instance states would be able to produce uniform definitions of a corporate entity and a non-corporate entity, at least the latter classification conflicts would only be due to the existence of two doctrines. Or if a list, similar to the list recorded in the Parent-Subsidiary Directive, would be used for uniform classification standards, again the conflicts would be restricted to the both principles. However, as is stated, both the incorporation and the real seat doctrine are accepted under European law. Therefore in the following part of this section will be focused on qualification of entities under tax law. It will become clear that several problems in tax law regarding qualification of entities, do not even relate to classification conflicts between either the incorporation or the real seat principle. Especially when is considered that if all states would use either the incorporation principle or the real seat principle, this would not mean that entities would be qualified similarly.

5.3.2 Autonomy in classification Member States levy taxes upon the basis of the principle of residence and the principle of source, by which correspondingly worldwide taxation on residents and source taxation on non-residents is applied. From European case law both principles have shown to be accepted. The ECJ has explicitly stated in Futura Participations that worldwide taxation for residents and source taxation for non- residents is in line with the fiscal principle of territoriality.326 This principle of territoriality can be described as: ‘A term used to connote the principle of levying tax only within the territorial jurisdiction of a sovereign tax authority or country. The underlying theory is that no taxes can be levied beyond its borders without violating the sovereign tax authorities of another state. Consequently, both residents and non-residents of a state adopting this principle are only taxed on the income from sources in that country and on property situated in that country. Residents are not taxed on any foreign source sourced income.327

In most countries this has developed into the principle of universality for residents and the principle of source for non-residents. For foreign source based income the resident state usually grants a tax relief.

326 ECJ 15 May 1997, C-250/95 (Futura Participations), point 5 and 20-22. More in general, in Futura Participations the ECJ stated that the allowance of only profits and losses in Luxembourg for limited taxpayers is in harmony with the fiscal principle of territorialism. The obligation to keep up a bookkeeping in order to determine these profits and losses is legit as an objective justification of public interest. The obligation to keep up a regular bookkeeping was however disproportionate, the need for a clear and accurate proof of the profits and losses was already sufficient. 327 International Bureau of Fiscal Documentation, IBFD International Tax Glossary, Amsterdam: IBFD Publications, 1992.

5. Qualification methods for foreign entities

In literature it is said that the justification for the application of worldwide taxation or the principle of universality for residents is the fact that this taxation catches the taxpayer‟s ability to pay.328 The application of both principles without providing tax relief in cross-border situations gives rise to double taxation. In the TFEU there is however no prevailing principle.329 This view is confirmed in case law, wherein is stated that Member States can define the criteria for determining tax allocation themselves, since no unifying or harmonizing measures have been made in the EU.330 Member States are furthermore considered competent in choosing how to grant tax reliefs to eliminate international double taxation. In this context it is however also stressed by the ECJ that international tax law usually lets the source principle prevail over the universality principle. By this reasoning the ECJ applies its view in compliance with the territoriality principle as described above.331 Keeping this in mind, Member States are very autonomous in determining which principle has priority over the other. But Member States also have to take notice of the international context. The significance of these differing principles lies in the fact that there is no existing European legislation that explicitly obliges Member States to prevent, eliminate or mitigate double (non-)taxation.332 Taxpayers are bound to rely on Member States‟ bilateral and unilateral tax treaties to prevent double (non-)taxation as a consequence of applying both the principle of residence and the principle of source. This extends to taxpayers having to rely on Member States‟ bilateral and unilateral tax treaties for a great part to prevent double (non-)taxation in the case of classification conflicts.

Another concept wherein Member States have a large amount of autonomy, is the classification of entities. The ruling of the ECJ Columbus Container Service created a legal basis for states to maintain this high level of autonomy in qualifying foreign entities for tax purposes333: ‘As stated in (…) this judgment, in the current state of harmonization of Community tax law, Member States enjoy a certain autonomy. It follows from that tax competence that the freedom of companies and partnerships to choose, for the purposes of establishment, between different Member States in no way means that the latter are obliged to adapt their own tax systems to the different systems of tax of the other Member States in order to guarantee that a company or partnership that has chosen to establish itself in a given Member State is taxed, at national level, in the same way as a company or partnership that has chosen to establish itself in another Member State.’

Potential inequalities in the light of the principle of equality in taxation concerning double taxation as a consequence of different classifications on a European level can therefore probably not easily be restricted on the basis of EC law.

328 CFE Opinion Statement on the Decision of the European Court of Justice Bosal Holding BV, Case C-168/01, Paper submitted by the Confédération Fiscale Européenne to the Council, the European Commission and the European Parliament in 2004, European Taxation, November 2004, p. 510. 329 G.K. Fibbe, 2009, p. 120. 330 ECJ 12 May 1998, C-336/96 (Gilly), second part of point 30. 331 CFE Opinion Statement on the Decision of the European Court of Justice Bosal Holding BV, Case C-168/01, Paper submitted by the Confédération Fiscale Européenne to the Council, the European Commission and the European Parliament in 2004, European Taxation, November 2004, p. 511. The fact that the ECJ attaches value to common used international principles can for example be found in ECJ 12 May 1998, C-336/96 (Gilly), point 31. 332 P.J. Wattel, Corporate tax jurisdiction in the EU with respect to branches and subsidiaries; dislocation distinguished from discrimination and disparity; a plea for territoriality, EC Tax Review 2003/4. 333 ECJ 6 December 2007, C-298/05 (Columbus Container Services), point 51.

5. Qualification methods for foreign entities

5.3.3 Art. 293 EC Treaty and the freedom of establishment In the old version of the Treaty establishing the European Community (EC Treaty), that was in force before the TFEU came into force, an interesting provision as regards mutual recognition of entities by states was recorded. Art. 293 EC Treaty namely stated that Member States had to enter into negotiations to ensure the mutual recognition of companies or firms within the meaning of the second paragraph of Article 48 (EC Treaty, art. 54 TFEU) as far as necessary for solving problems as a consequence of double taxation. This article constituted an obligation to try to eliminate problems, it could not be seen as a performance obligation. Art. 293 EC Treaty could however not be applied directly, since the ECJ has stated that even if a treaty concluded on the basis of art. 293 EC Treaty facilitates the freedom of establishment, this exercise of that freedom is nevertheless dependent on the specific provisions referring to this freedom.334 Therefore the fact that this article cannot be directly applied, significantly decreases its meaning for solving different qualifications of entities. Another aspect that diminishes the effect of the obligation for Member States to enter into negotiations regarding mutual recognition, is the fact that art. 293 EC Treaty is no more incorporated in the TFEU. The whole provision is lapsed. It is defended in literature that the amount of added value by this provision is however entirely integrated in the freedom of establishment itself, as it also was when art. 293 EC Treaty existed.335 I agree to this view, since on the basis of case law from the ECJ it is clear that art. 293 EC Treaty has no direct effect. Therefore a taxpayer would have to call upon one of the provisions referring to the specific freedoms in the treaty anyway. Even if the taxpayers would additionally call upon art. 293 EC Treaty, the grounds would still – maybe though in less detail – be covered by the freedom itself. The vanishing of the article thus seems not to have a great meaning with respect to the mutual recognition of entities so far.

5.3.4 Mutual recognition The concept of mutual recognition has come across several times in this thesis. In the legal comparison it became clear that a minority of the EUCOTAX Countries to some extent also uses recognition of an entity‟s qualification in the other state for domestic qualification for tax purposes. In general this concept has been seen as a means to contribute to the realization of the internal market, where the concept of harmonization was harder to accomplish, especially with the continuing growing number of Member States.336 In defense of this concept was stated that it contained competition possibilities for Member States, since their legislation would not have to converge. In contrary it would increase transaction costs.337 The limit of mutual recognition however was posed in the fact that its influence was restricted to the treaty freedoms, so that it could not resolve fiscal disparities.

334 ECJ 5 November 2002, C-208/00 (Überseering), points 54 and 55. 335 G.K. Fibbe, 2009, p. 106-113. 336 Communication of 14 June 1985 of the European Commission, „Completing the Internal Market: white paper from the Commission ot the European Council‟, COM(1985)310 final. 337 G.K. Fibbe, 2009, p. 47.

5. Qualification methods for foreign entities

Furthermore it has become clear that states classify entities autonomously. No general definition of a corporate or non-corporate entity exists. Several states classify a number of entities in their domestic civil or corporate law, but this does not extend to foreign entities. In addition to that, the principle of mutual recognition with respect to the qualification of entities has not been laid down in legislation up till today.338 And since it is very unlikely that a harmonized definition of entities will be established in the near future, the solution for qualification issues has to be searched for in other areas. To reach further harmonization or unification of tax classification conflicts between Member States, additional European legislation is necessary. Additionally, in the absence of European legislation on the qualification problem, it might be wise to focus on the prevention of double (non-)taxation issues regarding hybrid entities instead of focusing on unifying classification methods.

5.3.5 Parent-Subsidiary Directive Besides the list of entities recorded in the Parent-Subsidiary Directive, this Directive holds another interesting method for solving double taxation issues regarding the taxation of hybrid entities. In the Preamble to the 2003 text, paragraph 6, is stated that as far as entities are included in the Directive‟s list as corporate taxpayers in their Member State and qualified as transparent entities for tax purposes in the other Member State, the latter Member State should grant appropriate tax reliefs for the revenue that forms part of the parent company‟s tax base.339 This is further elaborated in art. 4 (1) (a) of the Directive. This part of the article consists of two sections. The first section states that if the resident state of the parent company qualifies the subsidiary as a fiscally transparent entity, profit distributions of the subsidiary to the parent company shall not be taxed accordingly by that state. This is represented in the picture on the right. The subsidiary is considered to be transparent for tax purposes by NL, the resident state of the parent company. Profits arising from this transparent entity are therefore directly allocated to the parent company and profit distributions from the subsidiary are not taxed accordingly. The second section states that the resident state of the parent company shall grant a tax relief for the profits arising from its share in the subsidiary, in the form of either a tax exemption or a tax deduction if some additional requirements are met.340 This is logical, since the subsidiary is a corporate taxpayer in its resident state and pays taxes on its profits there accordingly. More in general, Fibbe states that the general application of the Directive should be that every corporate taxpayer in a Member State that is subject to corporate income tax if it were situated in its

338 This is despite many attempts to create legislation with respect to the concept of mutual recognition, not specifically aimed at the mutual recognition of entities or even recognition for tax purposes. See G.K. Fibbe, 2009 p. 15-19 and p. 78-88 and footnotes accordingly. 339 Furthermore paragraph 8 in the Preamble to the 2003 text of the Parent-Subsidiary Directive might give rise to equal treatment of the by both other states fiscally transparently qualified entity (while qualified as non-transparent by the resident state) compared to a permanent establishment in a triangular situation. The PE should be treated equally to a subsidiary on the basis of this provision and granted Directive benefits. For a broad explanation is referred to Fibbe, 2009, p. 302-306. 340 Art. 4 (1) (a) Parent-Subsidiary Directive.

5. Qualification methods for foreign entities state of incorporation should be granted the Directive benefits.341 I think this does not plainly hold, for either triangular cases, and cross-border situations with only two states. In the cross-border situation with two states there is either the qualification of the entity as a corporate taxpayer, recorded in the list, in its resident state or the qualification of the entity as fiscally transparent in the resident state of the parent company. This different qualification is explicitly accepted in paragraph 6 of the Preamble to the 2003 text and implicitly by the methods for granting tax relief in art. 4 (1) (a) of the Directive. NL has implemented the working of these provisions by a Decree.342 Corporate legal forms not included in the list, cannot call upon Directive benefits as such. With respect to triangular cases, paragraph 8 in the Preamble to the 2003 text of the Directive constitutes equal treatment of a head office and a PE versus a parent company and a subsidiary regarding profit distributions. In my opinion Fibbe‟s statement does not hold for the triangular situation in the picture, if the entity in State B does not qualify as a PE for the Parent-Subsidiary Directive. There are three states are involved, from which State A and State C qualify the entity in State B as transparent, while the latter State qualifies the entity as corporate. Whereas Fibbe argues that State C should grant Directive benefits to the entity in State B – since it is a corporate taxpayer in State B – for for example a dividend payment to the entity in State B, which State C subsequently considers to flow through to the entity in State A, I disagree. State C considers the dividend payment to be made directly to the entity in State A due to the transparency of the entity in State B. If according to application of the Parent- Subsidiary Directive there is no PE of the entity in State A, State C should grant the Directive benefits to the entity in State A. The entity in State B is not entitled to Directive benefits based on its relation with the entity in State C. Moreover, even though it might by desirable, as Fibbe states, that all corporate taxpayers who are subject to corporate income tax if they are situated in its state of incorporation receive Directive benefits, I do not think this is what the Parent-Subsidiary Directive plainly constitutes. Only entities included in the list of qualifying entities, receive these benefits. On top of that the working of the Directive is extended to certain situations, as for instance described by the working of paragraphs 6 and 8 of the Preamble to the 2003 text. The general statement however does not hold in all situations, as is shown above.

By these provisions in the Directive, double taxation in the case of hybrid entities – at least in a cross-border situation with two states when the corporate taxpayer that is included in the list, is qualified transparent by the Member State of the parent company – is eliminated. It does not force Member State to accept the qualification in the other State, therefore the principle of mutual

341 Fibbe, 2009, p. 305-306. 342 Decree of 11 December 2009, nr. CPP2009/519M.

5. Qualification methods for foreign entities recognition does not play a role in this solution to prevent double taxation. The situation can however also be reversed. The entity can be qualified fiscally transparent in its resident state, while the resident state of the parent company qualifies the entity as non-transparent. This situation does not fall under the scope of the Parent-Subsidiary Directive, since this does only extend to entities that are qualified as corporate taxpayers in their resident state.343 It can however lead to double taxation or double non- taxation. A proposed solution, which has a similar effect as art. 4 (1) (a) Parent-Subsidiary Directive has, is to add a text to the existing article.344 This text states that the state of the parent company refrains from taxing the distributed profits, whereas these profits are taxed by the state of the fiscally transparent subsidiary, and additionally is allowed to tax the distributed profits that are not taxed by the latter state. This solution would, in combination with the already provided solution for the situation that is covered in the Parent-Subsidiary Directive, provide for a far-reaching solution for double taxation or double non-taxation issues in the case of hybrid entities. It does however not solve all problems regarding double (non-)taxation as a consequence of differently qualified entities.

5.4 Solutions in tax treaties

In international tax law different solutions with respect to hybrid entities are to be found, even though it has to be stressed that in most cross-border situations no specific provisions relating to the qualification problem as far as it leads to double (non-)taxation are provided for. In the following part, the solution provided by the OECD shall be discussed, after which specific provisions from double tax treaties from NL with a number of other states will follow. In succeeding order these are the USA, Belgium and Indonesia.

5.4.1 OECD Report 1999 A solution for double (non-)taxation issues regarding hybrid entities is proposed in the OECD Report of 1999.345 This is implemented in the OECD Commentary in specific articles and already in short described in paragraph 3.4.4. More in general, and also followed in European law, in the OECD- MC the principle of source prevails over the principle of universality.346 In that light two effects with

343 A.W.G. Lamers and A.J.A. Stevens, Classification Conflicts: The Cross-Border Tax Treatment of the Profit Share of Limited Partners, European Taxation, April 2004, p. 163-164. 344 A.W.G. Lamers and A.J.A. Stevens, Classification Conflicts: The Cross-Border Tax Treatment of the Profit Share of Limited Partners, European Taxation, April 2004, p. 163: ‘1b. Where the State of the parent company considers a subsidiary to be fiscally non-transparent on the basis of that State’s assessment of the legal characteristics of that subsidiary arising from the law under which it is constituted and therefore taxes the parent company on its share of the profits distributed by the subsidiary, whereas the State of the subsidiary considers it to be fiscally transparent and therefore taxes the parent company on its share of the profits, the State of the parent company shall refrain from taxing the distributed profits of the subsidiary, but only to the extent the profits of the subsidiary were taxed by the State of the subsidiary. To the extent the profits were not taxed by the State of the subsidiary, the State of the parent company is allowed but not forced to tax the distributed profits of the subsidiary.’ 345 The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999. 346 CFE Opinion Statement on the Decision of the European Court of Justice Bosal Holding BV, Case C-168/01, Paper submitted by the Confédération Fiscale Européenne to the Council, the European Commission and the European Parliament in 2004, European Taxation, November 2004, p. 510.

5. Qualification methods for foreign entities respect to hybrid entities can be distinguished, namely different qualification of entities and different treatment of (income of) entities, which are respectively the subjective and objective qualification. It has already been explained that a corporate entity has access to treaty benefits. This does not work out the same for non-corporate entities. Concerning non-corporate entities is stated in the OECD Commentary that partnerships are considered „persons‟.347 This does however not imply that the partnership is a „legal person‟.348 Furthermore is stated that a partnership is no resident if it is qualified transparent for tax purposes.349 Correspondingly is determined that partnerships only have treaty access and are thus eligible to treaty benefits, if they are qualified as residents on the basis of art. 4 OECD-MC.350 Therefore only entities qualified as corporate entities, or legal persons, have treaty access. In the case of partnerships that are not qualified as residents, the partners behind the partnership have access to the treaty if they are residents themselves. Taking the above explained vision into account, the OECD Report suggests that the domestic law of the resident state is decisive as to how and in the hands of whom an item of income is taxed.351 In case an item of income is taxed by the source state according to the tax treaty, the latter state does not have to take domestic legislation of the resident state into account regarding that item of income.352 Subjective qualification is up to the resident state as objective qualification is up to the source state, for items of income which can be taxed in the latter state according to the tax treaty. So in case of different qualification of an entity as respectively corporate and transparent, in combination with residency of the entity in one state and residency of the partners in the other state, the OECD Report advises to accept the income qualification by the source state and the partnership qualification by the resident state.

This solution being mentioned, a number of countries have made varying reservations to this proposed solution, including the Netherlands. NL has stated that it will not follow the proposed solution for all cases, since it feels there is no legal basis for it. NL only refers to the Report if similar conclusions are specifically agreed upon in double tax treaties on the basis of art. 25 OECD-MC or unilateral policy.353 In my opinion this is a perfect example of a provided solution, lacking enforceability by law. Progress is made by OECD research on relevant topics in the area of international issues of double (non-)taxation, but not all OECD Members apply the provided solutions without this being integrated

347 Commentary on art. 3, par. 1, point 2 OECD-MC. 348 Commentary on art. 3, par. 1, point 10.1 OECD-MC. 349 Commentary on art. 4, par. 1, point 8.7 OECD-MC. 350 Commentary on art. 1, point 4 and 5 OECD-MC. 351 The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, par. 102. 352 The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, par. 103. 353 The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, Annex II, par. 20-24.

5. Qualification methods for foreign entities in tax treaties. NL however has the endeavor of including a special provision on classification issues in treaties since the OECD Report of 1999.354

5.4.2 Article 24 (4) Treaty NL – USA One treaty that includes a provision on classification conflicts is the treaty between NL and the USA of 1992, which is based upon a very similar provision in the United States Model Income Tax Convention of 1996 (US-MC 1996). Art. 24 (4) Treaty NL – USA ensures that in case of an item of income, profit or gain derived through a person that is fiscally transparent under the laws of either state, such item shall be considered to be derived by a resident of a state to the extent that the item is treated for the purpose of the taxation law of such state as the income, profit or gain of a resident. This is an unique provision in the numerous treaties NL has concluded in international tax law, it is however a standard provision in the US-MC 1996 in art. 4 (1) (d).355 The provision sees to treaty application of an item of income that flows from one state to the other through an entity that is qualified differently by both contracting states, it does not see to differences in income qualification. The article indicates that the source state follows the qualification of the entity by the resident state, of either the entity or the partners of the transparent entity. This is in compliance with the suggested approach by the OECD. One interesting point can however be added to the description of this provision. In the case that both states consider an item of income to be derived by a resident of themselves, the Memorandum of Understanding to the Treaty determines that both states may tax this item of income accordingly.356 If art. 24 (4) of the Treaty NL – USA would directly be applied, the source state would consider the items of income addressed to the resident state as far as these are taxed there accordingly. The reason of the deviant application of the provision is the savings clause, art. 24 (1) Treaty NL – USA, which is standard in US Treaties.357 A savings clause prevents a decrease of domestic taxing possibilities as a consequence of the double tax treaty. So in other words, the treaty does not affect the taxation of the contracting states. To go even further, this approach can be defended in the light of the fact that there is merely a pure domestic situation when a resident derives income from an entity or a resident entity as such does.358 Since the Treaty NL – USA does not foresee in any subsequent measures to prevent double taxation in this kind of situation, double taxation will remain.

5.4.3 Protocol I, point 2 and 4 (b) Treaty NL – Belgium The Treaty between NL and Belgium of 2001 does not know a specific provision on hybrid entities, there is however a regulation in the Protocol that entails about hybrid entities. Protocol I,

354 Memorie van Toelichting, Kamerstukken II, 2003-2004, 29 632, nr. 3, p. 29. 355 Fiscale Encyclopedie De Vakstudie, Nederlands Internationaal Belastingrecht, onderdeel 1, Artikelsgewijs commentaar bilaterale verdragen, Verenigde Staten van Amerika, Artikel 24 Grondslag van de belastingheffing (Basis of Taxation). 356 Point 14, paragraph a of the Memorandum of Understanding to the NL – USA Treaty of 1992. 357 G.K. Fibbe, Enkele aspecten van de nieuwe bepaling inzake hybride entiteiten in het verdrag met de Verenigde Staten, WFR 2005/429. 358 This approach is also defended in by the OECD, see The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999, par. 131. It should be noted here that there is however no general consensus among all OECD Members on this point.

5. Qualification methods for foreign entities point 2 and 4 (b) Treaty NL – Belgium state that if an entity is qualified as corporate by one state and transparent by the other, for the application of the tax treaty the tax, income and property of the hybrid entity is considered to be tax, income and property of the partners proportionate to their entitlement to the property of the entity. Furthermore is stated that tax relief can be granted to the partners as far as necessary for already paid taxes by the entity. According to the Protocol, the treaty has to be applied by both states as if the partners of the entity conduct a business through a PE in the other state.359 Profits of the entity may then be taxed in that state to the extent that these are attributable to the entity, similar as they would be attributable to a PE in that latter state. All profits not attributable on the basis of this fictional PE approach, or if no PE can be considered present, may be taxed by the partners‟ state. Comparing this to the provision in the NL – USA Treaty, the latter treaty prescribes the source state to follow the qualification of the resident state and an item of income from a fiscally transparent entity shall be considered to be derived by a resident of a state to the extent that the item is treated for the purpose of the taxation law of such state as the income, profit or gain of a resident, whereas the Protocol in the NL – Belgium Treaty prescribes the partnership‟s state to follow the qualification of the entity in the partners‟ state.

5.4.4 Protocol I Treaty NL – Indonesia Another regulation in a treaty regarding hybrid entities can be found in the Treaty between NL and Indonesia of 2002 in Protocol I.360 It is stated there that in the case of a classification conflict regarding a hybrid entity, the competent authorities shall prevent double (non-)taxation as a consequence of applying the tax treaty. This can be accomplished by a mutual agreement procedure between the contracting states. Even though this provision does not prevent double (non-)taxation directly, it does offer a way to solve the problem bilaterally. It has to be taken into account that administration costs for such a procedure might be high an thus an impediment to call upon such a provision.

5.5 Hybrid entities in the neutral level playing field

Up till now the various qualification methods for foreign entities in the EUCOTAX Countries have been described, as well as several existing solutions in European law and double tax treaties for the problems regarding double (non-)taxation in the case of hybrid entities. In this paragraph will be reviewed which solution would be most desirable in the light of the level playing field that creates a certain state of neutrality regarding the choice of the legal forms of businesses.

359 A.W.G. Lamers and A.J.A. Stevens, Classification Conflicts: The Cross-Border Tax Treatment of the Profit Share of Limited Partners, European Taxation, April 2004, p. 161. 360 Similar provisions in the Protocol can be found in Treaties with Mongolia and Georgia. See A.W.G. Lamers and A.J.A. Stevens, Classification Conflicts: The Cross-Border Tax Treatment of the Profit Share of Limited Partners, European Taxation, April 2004, p. 161.

5. Qualification methods for foreign entities

5.5.1 Qualification methods in EUCOTAX Countries In the methods used in the EUCOTAX Countries, three general systems worth discussed here can be distinguished, namely the per se corporations in combination with an elective system, the comparability test and recognition of an entity‟s domestic qualification in foreign law. In my opinion none of these methods are perfectly suited to create the desired state of neutrality in the desired level playing field, although they can contribute to it to some extent.

The comparability test does not contribute to the neutral level playing field sufficiently. Since by this system the eventual qualification is based upon a country‟s domestic legislation, disparities between countries‟ systems regarding hybrid entities will not be solved. As long as these disparities between legislative qualification systems are not eliminated, the level playing field is not reached. If a basis for uniform legislative qualification could however be used, this comparability method could form a possible solution. In the EUCOTAX Countries there is one country that uses the list of corporate entities in the Parent-Subsidiary Directive as a guideline for qualification of foreign entities. An advantage of this list is that consensus between 27 Member States already consists on what entities should be qualified as corporate entities. A disadvantage of this list is that it is very static, the list is not supplemented with newly created corporate forms. This is logical, since the process of creating a uniform opinion for 27 Member States is not easy, but it is however required to reach the obliged unanimous decision- making needed for creating and adjusting Directives.361 I think a list of entities, qualifying as corporate entities, could be a good way to avoid a lot of qualification problems regarding hybrid entities. This cannot be the list recorded in the Parent-Subsidiary Directive, since in the first place it was not created for this purpose and in the second place it cannot be supplemented easily. A guideline in the form of a recommendation from the European Commission with a list of entities and an instruction how to qualify entities might provide a solution. The system of per se corporations in combination with an elective system is also partly based on a preset list, on which consensus needs to be reached in order to create an equal playing field between countries. In favour of this system can however be said that it is possible for entities not on the list to prevent double taxation by electing to be recognized in the for them most favourable legal form. This is a way to solve double taxation, but on the other hand it is also a way to create possibilities for double non-taxation as far as no law exists to prevent these situations. Above that, the authority to decide how to be qualified is then left over to the entity instead of to the entity‟s state, which is not desirable in my opinion. The third system, in which specific parts of law of domestic legislation for an entity are accepted for foreign qualification, which is more or less linked to the principle of mutual recognition, could

361 Art. 115 TFEU.

5. Qualification methods for foreign entities create an ideal level playing field to some extent.362 Neutrality is created in the sense that hybrid entities are qualified according to their specific domestic law and double (non-)taxation as a consequence of different subjective qualification of entities will be eliminated. Since states have proven to be very autonomous in their classification methods on the basis of European case law, this approach would fit into this background for at least a territorial perspective.363 It would mean that a part of the national autonomy has to be given up, since qualification in the other state prevails over domestic qualification methods for foreign entities. Furthermore this approach would attach a reasonable great amount of value to the principle of territoriality. The territory where an entity is established or conducted would be of overriding importance for its qualification. This approach seems to coincide somewhat to the OECD approach, in which subjective qualification in the resident state is followed, whereas objective qualification in the source state is followed. A disadvantage of this system could be that disparities between countries‟ law systems still lead to inequalities in the overall market. Because of the fact that countries qualify entities differently, the neutral level playing field pur sang in which entities have an equal starting point to compete in the market, will not be realized. This is a problem in both this system as in the system that uses the comparability test.

In general can therefore be concluded that none of the existing qualification methods for foreign entities in EUCOTAX Countries are perfect to create the neutral level playing field. Certain elements of the systems can contribute to the level playing field, but an alternative method has to be found in order to reach the ideal situation.

5.5.2 Desired alternative Since none of the EUCOTAX Countries uses a system that is perfect to assure the creation of a neutral level playing field with respect to the qualification of entities, it is needed to examine what system would. Several existing European based methods as well as solutions in either the OECD-MC or double tax treaties have been discussed. As became clear, classification conflicts in tax law would not be solved if all states would use either the incorporation or the real seat principle. Furthermore European law lacks a legal basis to prevent double taxation, also with respect to mutual recognition of entities.364 Mutual recognition seemed to be a good way of creating a level playing field, but in Columbus Container Services365 the ECJ made clear that states are very autonomous in qualifying entities. Then the combined possibilities of the list and the extended working through certain paragraphs in the Parent-Subsidiary Directive seemed to give way to a far reaching solution regarding

362 By specific parts of law is referred to corporate, commercial or for instance civil law. 363 ECJ 6 December 2007, C-298/05 (Columbus Container Services). 364 The latter part specifically since this part of art. 293 EC Treaty is not converted into the TFEU, if it even had any legal meaning that was not included in the freedom of establishment in the first place. 365 ECJ 6 December 2007, C-298/05 (Columbus Container Services).

5. Qualification methods for foreign entities double (non-)taxation as a consequence of differently qualified hybrid entities. This however does not cover all situations, so it is not entirely sufficient to create the desired level playing field. By the OECD is explicitly chosen for a system, partly comparable to some EUCOTAX Countries‟ methods that partly accept an entity‟s domestic qualification, namely Belgium, Poland and UK. By following the subjective qualification by the resident state and leaving the objective qualification to the other state for income attributed to that state by the tax treaty, the territorial approach seems to be accepted by the OECD. As already said, this territorial approach can contribute to the prevention of double (non-)taxation as a consequence of different qualifications, but it does not eliminate disparities between counties‟ systems. The level playing field that would be reached by implementing this system would consist of one that grants entities an equal starting point as to not being subject to double taxation. It would however not give entities a neutral point of departure to compete in the market. From the discussed solutions in tax treaties one approach, differing from all approaches that have been discussed previously, is the one in the Protocol to the Treaty NL – Belgium of 2001. This treaty prescribes to follow qualification in the state of the partners of an entity in the case of differently qualified hybrid entities and both states have to esteem a PE present in the partnership‟s state for attribution of income to either the entity or the partners. I believe this is a somewhat long-winded manner of eliminating qualification problems.

This shows that finding the best way of creating a neutral level playing field for hybrid entities, while ensuring the prevention of double (non-)taxation, is not easy. The system that I find ideal in order to best accomplish this goal, would be a combination of an uniform list of qualifying entities, as either corporate or transparent, and a supplemental instruction to accept subjective qualification for non-listed entities. A condition would be that this list should easily be complemented with new legal forms. By using a system like this, countries would be entitled to see their entities qualified similarly abroad and taxpayers would have an enlarged legal certainty. Or in other words, the subjective qualification would be decisive as well as the fact that the territorial approach would be accepted and applied by all states. I think an advantage of a solution like this would be that domestic legislation would prevail. As is clear, it is not likely that countries are very willing to give up their sovereignty in the tax area. By this system, most of their sovereignty is preserved. A small part of their sovereignty would have to be given up, namely the fact that countries would have to accept qualification of entities in other jurisdictions for their domestic tax purposes. This would however only mean a change for cases in which entities will be qualified differently by this system than they were before by other systems. A disadvantage might be that an entire neutral level playing field will not be reached through this system, since not all entities will have an equal starting point to compete in the market because of

5. Qualification methods for foreign entities countries‟ differing qualification methods as regards domestic entities. Despite that, I believe this is the best way of creating a larger neutrality between legal forms.

It can be added to this discussion that an international uniform qualification method for foreign entities would be the most ideal solution that would fully create a neutral level playing field with respect to hybrid entities. Besides the fact that such a system cannot be reached, primarily because such a legislative authority lacks, I believe states value their tax sovereignty too much to give this up on such a scale. Therefore I think it is better to find a solution that respects the principle of territoriality to a certain extent. In the extension of respecting a state‟s territory, dealing with objective qualification of items in the source state has to be addressed too. To best respect both states‟ interests, firstly subjective qualification of an entity in its resident state is decisive. Secondly, if an item of income is attributed to the entity in the source state, I believe this should be qualified on the basis of the double tax treaty between these countries. Adequate measures to prevent double taxation should be recorded in the double tax treaty accordingly.

This theoretical view partly coincides with the OECD approach, but the execution is different. Since no international authority with legal power exists, the best way of creating the proposed solution is a recommendation from the European Commission that embodies this system. This recommendation would thus include an easily adaptable list of qualifying corporate or transparent entities and an advice to accept subjective qualification for non-listed entities. Furthermore the working of this system should assure objective qualification to be left over to the source state according to double tax treaties. This could be realized by an integrated advice in the recommendation from the European Commission. It would have to be examined to what extent it is possible and desirable to expand this system to third countries.

5.6 Conclusion

A legal comparison of qualification methods for foreign entities in EUCOTAX Countries is given, which all at least to some extent differed. Similarities could be found in certain countries using a list, while others used a comparability test and yet others accepted foreign law for qualification for domestic purposes. In the latter system it may be of importance whether a state adheres to the incorporation or the real seat principle. On the basis of European law it became clear that both principles are accepted and above that, adhering to one principle for all countries would not solve the qualification problem regarding differently qualified hybrid entities for tax purposes if these principles are not decisive for classifying entities.

5. Qualification methods for foreign entities

European legislation lacks a legal basis for the prevention of double (non-)taxation. Case law from the ECJ has however shown that countries may apply both the principle of source and the principle of universality, but the principle of source prevails. Additional European case law has shown that states are very autonomous in classifying entities for domestic tax purposes.366 Furthermore European law knows several concepts to solve problems regarding different qualifications of hybrid entities. The first is art. 293 EC Treaty, which stated that Member States had to enter into negotiations to ensure the mutual recognition of entities. This article however had no direct working and its effect can therefore be considered to be included in the freedom of establishment itself, besides the fact that it is not incorporated in the TFEU. The second is the concept of mutual recognition, in which states accept qualification of an entity in the other state. Within European law it is however bound to the treaty freedoms and therefore cannot erase fiscal disparities between countries‟ systems. It has however deemed to be a good way to improve the harmonisation process in the EU for a long time, without national legislations having to converge. The third concept is the usage of the already existing list in the Parent-Subsidiary Directive and the extended working of the Directive by paragraph 6 and 8 of the Preamble to the 2003 text in the case of differently qualified entities. The Parent-Subsidiary Directive was however not created to eliminate qualification issues regarding hybrid entities, its benefits are also not plainly eligible to all corporate taxpayers and it does not see to all double (non- )taxation cases regarding hybrid entities. The OECD has tried to come up with a solution regarding hybrid entities by leaving the subjective qualification of an entity to the resident state and the objective qualification to the source state. This would ensure equal treaty access from the perspective of both states as well as equal qualification of the relevant income. Its disadvantage is its lacking of enforceability by law. NL has also concluded several double tax treaties that include a provision seeing to hybrid entities. The Treaty NL – USA of 1992 includes a provision that treats income derived through a fiscally transparent person under the laws of either state to be considered to be derived by a resident of a state to the extent that the item is treated as income for the purpose of tax law for such state. The Treaty NL – Belgium of 2001 states that in the case of a differently qualified hybrid entity, the income of this entity is considered to be income of the partners. The treaty has to be applied as if a PE is present in the partnership‟s state for the attribution of income. The Treaty NL – Indonesia includes merely an provision that authorities shall prevent double (non-)taxation in the case of hybrid entities by a mutual agreement procedure.

To reach the desired level playing field that creates a certain state of neutrality between the legal forms of businesses, none of the EUCOTAX Countries‟ methods seemed to be perfectly fit. Moreover, none of the existing methods in both European law as in the international context did. The most ideal system would be a combination of an uniform – easily adjustable – list of qualifying

366 ECJ 6 December 2007, C-298/05 (Columbus Container Services).

5. Qualification methods for foreign entities entities, as either corporate or transparent, and an instruction to accept subjective qualification of non- listed entities. This system would adhere to the principle of territoriality regarding the qualification of entities. To accomplish this preservation of a great deal of sovereignty in qualifying domestic entities, this sovereignty would be slightly decreased regarding foreign entities. The objective qualification for income in the source state would be accepted under this system. The system can be shaped into a recommendation from the European Commission and it would have to be examined whether if and how this system should be expanded to third countries. I believe this system wherein states‟ territories are respected, is more desirable than creating an entire neutral level playing field through a system with uniform definitions and qualification methods, since then too much national sovereignty has to be surrendered. The small imperfections regarding neutrality in the level playing field in the recommended system through the slight disparities in domestic qualification methods, are a small sacrifice compared to the actual jumble of different methods and classification conflicts without suiting solutions.

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6. Group taxation systems and cross-border loss relief

6.1 Introduction

In this chapter the topics group taxation systems and cross-border loss relief will be discussed, based on a legal comparison between the EUCOTAX Countries. The first part will focus on a description of the various existing systems regarding group taxation in the EUCOTAX Countries. In this description attention is also paid to loss relief possibilities within groups. Group taxation in the EUCOTAX Countries will generally be discussed in the light of the principle of equality, before reviewing the scope of influence of European law on this topic. This is done by a description of European case law on group taxation and cross-border loss relief in the light of the principle of equality in taxation. The desirability of a cross-border group taxation system is then discussed in the light of the Communication of the European Commission on „Tax Treatment of Losses in Cross- Border Situations‟ and additionally in the light of the announced territorial approach as regards foreign losses of PEs from the Dutch State secretary of Finance.367 Next, the neutral level playing field of a cross-border group taxation system will be related to the group taxation systems in the EUCOTAX Countries. At last attention will be given to a wishful alternative for a cross-border group taxation system that will contribute to reaching the desired level playing field, consisting of a certain state of neutrality regarding the different legal forms. Finally a conclusion will list the whole.

6.1.1 Equality and PE versus subsidiary In the fourth chapter an extensive range of topics concerning the PE, the subsidiary and equality between these legal forms has been discussed. More in general it has become clear that on the basis of the freedom of establishment in European law, PEs and subsidiaries are treated more and more alike. From the perspective of the host state the PE has acquired the right to be treated no less favourable than the subsidiary, provided that they reside in comparable situations. This means that their economic activities have to be comparable as well as they both need to be subject to the same tax legislation. From the perspective of the home state some nuances can be made regarding this equal treatment. The freedom of establishment constitutes the obligation for home states not to restrict establishment in another state for both the PE and the subsidiary. Home states do however not have to grant similar tax treatment to a foreign PE and a foreign subsidiary, since these legal forms are not totally comparable. This difference is mostly due to the fact that PEs are not legally independent and therefore primarily subject to two tax jurisdictions, while subsidiaries are legally distinct entities and

367 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final and Letter to the Second Chamber of 5 December 2009, Stand van zaken mogeljke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14.

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6. Group taxation systems and cross-border loss relief primarily only subject to one tax jurisdiction.368 In the following part of this chapter will be examined to what extent PEs and subsidiaries should be equally allowed to participate in group taxation systems and have the same right to loss offsetting possibilities, in order to reach a level playing field for these different legal forms with a more neutral taxation.

6.2 Group taxation systems

The existing group taxation systems in the EUCOTAX Countries know a lot of distinctions between them, if there even is a group taxation system in a country. The countries that do know some sort of group taxation, have systems varying from domestic groups, to groups that can include domestic entities and domestic PEs from foreign entities, to cross-border groups that all deal with cross-border loss relief within the group differently. This will be discussed in more detail in the following section. The legal comparison will contain only main features of the systems in the EUCOTAX Countries. It goes beyond the scope of this thesis to explore all aspects and details of each system. The required amounts of shareholding, voting rights, the consequences for intercorporate transfers, intercorporate dividends and specific aspects regarding dissolution are not included in the research scope. Nor does it contain which legal forms qualify to participate in the group taxation system and the possible requirement of a reasonable taxation. A general comparison of the EUCOTAX Countries‟ systems will be given, to evaluate their compatibility with the neutral level playing field further in the text.

6.2.1 Group taxation – a legal comparison As can be seen in the picture of the legal comparison, there is one country – Belgium – that does not know a group taxation regime at all. This is despite the extensive discussion in both literature as in

Group taxation system politics on this Austria Cross-border group taxation system up till one level of foreign subsidiaries. Also cross-border loss subject.369 Then offsetting if domestic possibilities are utilized by foreign subsidiaries Belgium n/a Poland and the France Yes, including domestic PEs from foreign entities. Parent files consolidated tax return Germany Yes, including domestic PEs from foreign entities. Parent files consolidated tax return USA both do Italy Worldwide group taxation system with all-in all-out principle and consolidated tax return know a group NL Yes, including domestic PEs from foreign entities. Parent files consolidated tax return Poland n/a (only domestic entities) taxation system, Sweden Cross-border group contributions only for Swedish territory (foreign companies subject to tax in Sweden and established in EEA). No consolidated tax return but this is UK Group relief for EU/EEA entities or UK branches. Losses can be surrendered and claimed by group limited to members if not possible in resident state. No general consolidated group tax treatment USA n/a (only domestic entities) domestic entities. Subsequently there is a third group of countries, namely France, Germany and NL. Slight

368 P.J. Wattel, Corporate tax jurisdiction in the EU with respect to branches and subsidiaries; dislocation distinguished from discrimination and disparity; a plea for territory, EC Tax Review 2003/4. 369 P. Minne, „Group Taxation. Belgium.‟, IBFD, 2004. (Cahiers de Droit Fiscal International, Volume 89b).

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6. Group taxation systems and cross-border loss relief differentiations between their systems exist, but all of them know a group taxation system in which only domestic entities and domestic PEs of foreign entities can be included under particular conditions. Within these groups profits and losses can be offset and the parent of the group files a consolidated tax return. Specific requirements to enter into the group differ per country.370 Sweden knows a group taxation scheme that is roughly comparable to the systems in these three countries. Offsetting profits and losses is also possible within the group on the Swedish territory by means of group contributions, but there is no separate taxation group as such that can file a consolidated tax return. Worldwide groups of companies can be formed on the basis of company law for non tax purposes, tax law disregards these groups. Additionally three countries, Austria, Italy and UK, use some sort of cross-border group taxation system. All three do not resemble qua legislative and economic organisation. Firstly the UK group relief system, which is a EU/EEA-wide taxation system. UK tax legislation knows no specific consolidated group tax treatment as such, but it is possible to offset profits and losses under certain conditions within groups of companies. An entity can be eligible to group relief if it complies to the specific legislative conditions and if it is established in the EU or EEA.371 Group entities may claim losses of other group entities and the latter entities may surrender those losses to other group entities.372 Losses of UK PEs from foreign group entities may only surrender losses if these are not relievable in their resident state. Non-resident group entities may surrender losses which may be claimed by UK entities only when non-UK loss relief possibilities are exhausted. Secondly there is the Italian system, which is shaped into two different systems. Italy knows a domestic tax consolidation for groups of companies, comparable to that of France, Germany and NL, and Italy knows a worldwide tax consolidation for groups of companies.373 In this context only the latter will be discussed. The worldwide group consolidation is only optional if all foreign controlled subsidiaries are included in the group, also known as the all in all out principle. Profits and losses are consolidated within the group and the regime can only be elected for a mandatory period.374 All profits and losses of domestic group members are consolidated regardless of the percentage of participation. Profits and losses of foreign group members are consolidated with regard to the amount of participation. The credit method is applied to eliminate double taxation. This is one of the two EUCOTAX Countries that actually has a worldwide taxation system. Thirdly there is the Austrian system of group taxation, introduced in 2005.375 Entities are allowed into the group up to one level of foreign entities, provided that these are comparable to Austrian stock companies, limited liability companies or cooperatives. The group parent company can either be an

370 For these detailed specific requirements per country is referred to the EUCOTAX Papers on „The principle of equality in taxation & The choice of the legal form‟ and the IBFD Country Guides 2010. 371 IBFD Country Guides 2010, United Kingdom – Corporate Taxation, Group taxation. 372 Section 403ff Income and Corporation Taxes Act 1988 (UK). 373 Non-resident subsidiaries can be included in the group, see art. 130 et seq. Italian Testo unico delle imposte sui redditi (Income Tax Act). 374 When first choosing the worldwide consolidation the mandatory time is five years. After this period has ended it can be extended with periods of three years. See IBFD Country Guides 2010, Italy – Corporate Taxation, Group taxation. 375 The Austrian group taxation system is constituted in Section 9 Körperschaftsteuergesetz (Corporate Income Tax Act).

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Austrian corporate entity or a non-resident corporate entity with an Austrian PE.376 In this system of group taxation all profits and losses of the domestic subsidiaries are attributed to the group parent irrespective of the amount of participation in the subsidiaries. Profits and losses of the foreign subsidiary, calculated on the basis of Austrian tax law, are attributed to the parent on the basis of the amount of participation. Losses of a non-resident group entity can be offset within the group, but are recaptured when domestic loss relief becomes available. Losses of non-resident group entities can eventually only be offset within the group under strict conditions, to assure the prevention of double loss relief. The Austrian system is the second of the two worldwide taxation systems.

6.2.2 Group taxation systems and equality Based on this legal comparison there is an extensive range of group taxation systems. It begins with no group taxation system, group taxation for only domestic entities, group taxation for domestic entities and domestic PEs from foreign entities and it ends with cross-border group taxation systems, some with restrictive loss relief measures. Before reviewing these systems in more detail with respect to their compatibility with European law, especially in combination with the aspect of cross-border loss relief, the systems will generally be discussed in the light of the principle of equality.

It stands out that Belgium is the only country that does not know any form of group taxation. As a consequence there will be equal treatment for domestic and foreign entities in that respect, since none of all entities can enter into a group. Although this seems fair with respect to the principle of equality, it would be better from a competitive point of view towards the market to introduce a form of group taxation. As regards the group taxation systems limited to domestic entities, can be said that in the light of the principle of equality these countries treat domestic entities more favourable than foreign entities. While no law compels the USA to do otherwise, this does not hold for Poland. This EU Member State should keep to European law obligations, which clearly imply that a host state has to grant similar tax treatment to domestic entities as domestic PEs from foreign entities.377 All profits and losses attributable to a PE are on the basis of a tax treaty or the OECD-MC assigned to the source state of the PE. By means of this attribution of taxing rights, the tax base for Poland is assured. Then there is no reason to exclude the domestic PE of the foreign entity from profiting from a domestic group taxation system. In my opinion therefore the Polish group taxation system should be expanded to at least a group taxation system that would include domestic entities and Polish PEs from foreign entities. The system would then be more in compliance with the principle of equality from a European perspective.

376 Non-resident entities with an Austrian PE qualifying for being a group parent company must be listed in the Annex to the Parent- Subsidiary Directive (90/435/EEG) or be comparable to a resident company and have its place of management in the EEA. See IBFD Country Guides 2010, Austria – Corporate Taxation, Group taxation. 377 See amongst others ECJ 28 January 1986, C-270/83 (Avoir Fiscal), ECJ 13 July 1993, C-330/91 (Commerzbank) and ECJ 22 April 1999, C-311/97 (Royal Bank of Scotland).

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The French, German, Dutch and Swedish group taxation systems clearly adhere a territorial bound approach by not allowing foreign entities into the group. In the light of the far going tax sovereignty of states this is understandable. From an economic point of view this however impedes free competition in the global market on the basis of territorial restrictions. European case law on these kind of group taxation systems will be elaborated in more detail in the following paragraph. One interesting aspect however is the Swedish group taxation system that from a company law point of view is a worldwide group system, but in tax law is limited to a territorial bound group system. Only domestic entities and domestic PEs from foreign entities can offset profits and losses. This system provides a way for companies to profit from civil and economic advantages of forming a group, without erasing Swedish taxing possibilities or the Swedish tax base. From the three cross-border group taxation systems, only UK has limited its group taxation system to entities established in the EU/EEA. In the light of the principle of equality in European law this can be defended, it does however not contribute to a global equality between resident and non- resident entities. Austria and Italy allow worldwide non-resident entities into the group under certain conditions. Austria has implemented restrictive measures regarding cross-border loss relief and Italy prescribes worldwide consolidation for the entire group. By means of such systems domestic and foreign entities are treated similarly, without easily giving away the domestic tax base. On a global level, these systems treat domestic and foreign entities more equal than the systems that are restricted to domestic entities and domestic PEs from foreign entities. This will be reviewed in more detail regarding European case law further below. One specific detail that might not be in compliance with the principle of equality in European law in my opinion, is the all in all out principle in the Italian worldwide group taxation system. The principle is known to be an anti-abuse measure, but it might be considered disproportionate to its goal. In order to assure the Italian taxing rights, or in other words to assure that the Italian tax base is not eroded, less limiting measures can be applied. Italy can prevent abuse of cross-border loss relief within groups for instance by measures similar to those in Austria or UK. In my opinion the all in all out principle is a limitation of the freedom of establishment that cannot be justified on the basis of the anti-abuse argument, since that is disproportionate to its goal. Furthermore the all in all out principle restricts entities to decide individually whether or not to participate in the group taxation system. To create a neutral tax perspective this is not optimal, since as has been stated before, tax considerations should not influence business decisions. It might however be possible to justify the all in all out principle on the basis of a combination of objective justifications. It goes beyond the scope of thesis to examine this.

All of these systems thus know a certain extent of equality, but also a certain extent of inequality. The difference in legal form of entities, PEs or subsidiaries, partly justifies an unequal treatment. The freedom of establishment in European law however demands equal treatment of these legal forms to

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6. Group taxation systems and cross-border loss relief some extent as well. As does the neutral level playing field for the EUCOTAX Countries. To decide which of the EUCOTAX systems is most desirable to reach the neutral level playing field, on either a European level or internationally, compatibility with European case law will be discussed.

6.3 Group taxation systems and European law

Impediments to the TFEU freedoms are eliminated as much as possible on the basis of European law to stimulate the internal market. Extensive case law has emerged regarding the freedom of establishment related to carrying out cross-border activities through a permanent establishment or a subsidiary. European case law that is relevant in the perspective of group taxation will be elaborated in the following section. Additionally this will be evaluated in the perspective of the existing systems in the EUCOTAX Countries. In this paragraph is focussed on inbound situations. As already described before, the host state has to grant similar tax treatment to domestic entities as domestic PEs from foreign entities.378

6.3.1 European case law on group taxation systems First of all the influence of Marks & Spencer II379 on group taxation systems is relevant. In this case a UK parent company owned several foreign subsidiaries in the EU. In dispute was whether the losses of the foreign subsidiaries could be offset against profits by the UK parent company. The UK group relief system was only available to resident entities. The ECJ ruled that unequal treatment of domestic subsidiaries that can offset their losses at the level of the domestic parent company, compared to foreign subsidiaries that cannot offset their losses at the level of the domestic parent company, is not contrary to the freedom of establishment. Grounds of justification are the balanced distribution of taxing rights, the prevention of double loss relief and the prevention of tax avoidance. This unequal treatment is however considered contrary to the freedom of establishment by the ECJ if the foreign subsidiary has exhausted its possibilities to take losses into account in its resident state and additionally will not have the possibility to take the losses into account in its resident state in the future.380

Dutch Supreme Court‟s Advocate General Wattel took the view that this decision does not have any implications for the Dutch group taxation system concerning loss relief, since NL treats domestic PEs and domestic subsidiaries equal by allowing domestic subsidiaries to enter into the fiscal unity.381

378 See for instance ECJ 28 January 1986, C-270/83 (Avoir Fiscal), ECJ 13 July 1993, C-330/91 (Commerzbank), ECJ 22 April 1999, C- 311/97 (Royal Bank of Scotland) and ECJ 21 September 1999, C-307/97 (Saint-Gobain). 379 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 380 The Dutch system seems in compliance with this decision, art. 13d and 13e CITA. See E.C.C.M. Kemmeren, Marks & Spencer: balanceren op grenzeloze verliesverrekening, WFR 2006/211. 381 Note from Advocate General Wattel Dutch Supreme Court to ECJ 13 December 2005, C-446/03 (Marks & Spencer II), BNB 2006/72c.

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The ECJ did not clarify whether the exclusion of foreign subsidiaries from the fiscal unity is allowed. Since this was not decided upon in Marks & Spencer II, a preliminary ruling upon this subject was unavoidable. In my opinion this decision of the ECJ perfectly shows that there are limits to the amount of negative integration the ECJ can achieve by its case law. The ECJ is not the right institution to prescribe a cross-border group taxation system. Specific integration in the light of the internal market has to be left over to the process of positive integration. Nonetheless after Marks & Spencer II, several other relevant decisions from the ECJ regarding group taxation systems have passed review.

In 2008 the ECJ ruled Papillon382, making clear that the freedom of establishment leads to a prohibition of a group taxation system that includes domestic parent companies, domestic subsidiaries and domestic sub-subsidiaries, but excludes domestic sub-subsidiaries that are held by a foreign subsidiary.383 Although this decision concerned the French group taxation system, several other EU Member States did not allow domestic sub-subsidiaries held by foreign subsidiaries of a domestic parent company in groups.384 Even though Papillon is a broadening of the group taxation regime as known before this decision, whereas several countries know the system that includes domestic entities and domestic PEs from foreign entities, it still permits group taxation systems to be bound to a country‟s territory. A worldwide group taxation system, or a EU group taxation system, does not seem to be obliged on the basis of European case law.

Recently the ECJ has ruled X Holding BV385, in which judgment was passed upon whether foreign subsidiaries have to be allowed into the Dutch fiscal unity. As is described earlier, the ECJ ascertained a justified impediment to the freedom of establishment by excluding foreign subsidiaries from cross- border loss relief through a group taxation system in the light of the balanced distribution of taxing rights between Member States. The ECJ has continued on its line from Marks & Spencer II regarding the permitted distinction from the perspective of the home state between loss relief possibilities for foreign PEs and for foreign subsidiaries. In X Holding BV the ECJ states that the fact that a Member State temporary permits offsetting losses of a foreign PE at the level of the head office does not mean that that possibility also has to be extended to non-resident subsidiaries. Foreign PEs from resident entities and non-resident subsidiaries are not comparable with regard to the power of taxation as provided for in a double tax treaty and with regard to unlimited liability to tax in different jurisdictions.

382 ECJ 27 November 2008, C-418/07 (Papillon). 383 In this context the subsidiary of the parent company is the first tier subsidiary and the sub-subsidiary of the parent company is the second tier subsidiary. 384 Also valid for NL, see Note to ECJ 27 November 2008, C-418/07 (Papillon), V-N 2008/59.20. 385 ECJ 25 February 2010, C-337/08 (X Holding BV).

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Therefore even though foreign PEs can temporary offset losses at the level of the domestic parent company, the incomparability of foreign PEs with foreign subsidiaries leads to the right for a Member State to disallow foreign subsidiaries into the system of the fiscal unity.

6.3.2 EUCOTAX Countries and European case law on group taxation systems Taking this case law into account, it seems as if the ECJ tries to assure the secondary freedom of establishment, but does allow certain impediments leading to a not entirely equal treatment of entities. From the perspective of the host state, equal treatment – unless an objective justification exists – has to be granted to a domestic entity versus a domestic PE of a foreign entity. Reviewing this in the light of the group taxation systems of the EUCOTAX Countries, this is exactly what the French, German, Dutch and Swedish systems do. The Polish system does not comply to this obligation in my view. Furthermore Austria, Italy and UK go even further than this territorial application of group taxation systems by allowing foreign entities into groups of companies. Case law has led to the establishment that whereas foreign PEs are not comparable to foreign subsidiaries, these different legal forms do not have to be granted equal treatment by the home state. The latter three EUCOTAX Countries do allow foreign subsidiaries into their group taxation systems. The ECJ has explicitly stated that losses of foreign PEs do not have to be treated the same as losses of foreign subsidiaries. So, despite the fact that some Member States temporary allow losses of foreign PEs to be offset at the level of the domestic head office, this privilege does not have to be granted to foreign subsidiaries. The exclusion of offsetting losses insofar they can be offset in the resident state of a foreign subsidiary is thus in line with the principle of equality form a European law perspective. The systems of the EUCOTAX Countries that know a cross-border group taxation scheme that include some sort of restrictions regarding cross-border loss relief can be considered in line with European case law. 386

6.4 Cross-border loss relief

In the light of the neutral level playing field will be examined whether it would be desirable to create cross-border group taxation schemes. These systems would allow foreign entities to be part of the group, while the foreign group entities would be bound to restricted cross-border loss relief possibilities. To review how this restricted cross-border loss relief would have to be established and relate to European law, this will be discussed in the following text. In this paragraph will be focussed on outbound situations. Firstly specific European case law on cross-border loss relief will be considered to describe how this relates to the desired cross-border group taxation systems. Secondly the considerations regarding

386 Meant is the Austrian and UK system.

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6. Group taxation systems and cross-border loss relief cross-border loss relief in the Communication of the European Commission: „Tax Treatment of Losses in Cross-Border Situations‟ will be evaluated in the light of cross-border group taxation systems. This will be related to the level playing field in the internal market through the Corporate Consolidated Corporate Tax Base (CCCTB). Furthermore the announcement of the Dutch State secretary of Finance to introduce a more territorial approach concerning PEs will be discussed in relation to the desired cross-border group taxation systems.

Both foreign PEs and foreign subsidiaries can be granted cross-border loss relief to some extent and under certain conditions in almost all EUCOTAX Countries. For foreign subsidiaries can generally be said that due to the fact that a subsidiary is a legally independent entity, the offset of losses on the level of the parent company is not possible, with sometimes exceptions in the case of group taxation systems and cross-border loss relief as a consequence of European case law. With respect to offsetting losses in the case of a foreign PE, the systems vary from allowance, to exclusion of cross-border losses within the exemption method, to a tax relief according to the credit method. This has been explained in paragraphs 4.2.4 and 4.3.1. Next, specific case law from the ECJ on cross- border loss relief will be explained after which this is discussed in the light of the Communication of the European Commission.

6.4.1 European case law on cross-border loss relief As a first, Marks & Spencer II387 sees to cross-border loss relief between parent companies and subsidiaries. The UK restrictive provisions, disallowing cross-border loss relief between companies, were a limitation to the freedom of establishment that could be justified on the basis of the need for a balanced distribution of taxing powers between the Member States, prevention of double loss relief and the prevention of tax avoidance. The system was however not proportional if the possibilities for offsetting the losses in the subsidiary‟s resident state had been exhausted. An interesting point with respect to this mandatory cross-border loss relief possibility is brought up by Kemmeren.388 He states that the Court, by concurring with existing national legislation for allowing a loss transfer, realizes equal treatment of domestic entities versus foreign entities with exhausted national loss relief possibilities. This is however only possible if the resident state of the parent company knows some sort of loss relief provisions. Hereby is implied that Member States could try to decrease the effect of Marks & Spencer II by eliminating or reducing loss relief possibilities from their national legislations. This is of course not desirable from the viewpoint of the internal market. By the Marks & Spencer II case, Member States are obliged to import foreign losses into the domestic tax base, without ever being able to import foreign profits from those same entities. A

387 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 388 E.C.C.M. Kemmeren, Marks & Spencer: balanceren op grenzeloze verliesverrekening, WFR 2006/211.

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6. Group taxation systems and cross-border loss relief brought up alternative in this case was the condition that the transferred loss would be offset to a same amount of future profits of the foreign entity. This would mean that an amount of profits, equal to the amount of offset losses, would be included in the tax base of the domestic parent company. An additional anti-abuse measure would have to be created to make sure an entity cannot make use of double loss relief. The ECJ found these measures to be more restrictive than needed to reach the desired goal.389 Furthermore, this would mean a breach of a Member State‟s taxing rights on the basis of the principle of universality. Seen in this light, I think this decision can partly be seen as a justification for not allowing foreign entities into a group, since then the possibilities to offset cross-border losses might increase disproportionally. After the evaluation of the rest of the case law, will be decided how this relates to an obligation on a European level to create cross-border group taxation systems.

A second relevant decision from the ECJ is Lidl Belgium.390 In this case a German entity conducted business in Luxembourg through a PE that generated losses. According to the double tax treaty the income generated by the PE was allocated to Luxembourg. In dispute was whether the losses of the PE were to be offset at the level of the German head office. The ECJ determined that there was a restriction of the freedom of establishment, compared to losses of German PEs that could be offset at the level of German head offices. This was however justified on the basis of the need for a balanced allocation of taxing powers between the Member States and the prevention of double loss relief. Advocate General Sharpston concluded in this case however that the method of excluding foreign PE losses was disproportionate in the light of the freedom of establishment. She based this conclusion upon the fact that less restrictive measures would be sufficient to prevent double loss relief and a balanced allocation of taxing powers between the Member States. A system of granting tax relief for results of foreign PEs, combined with the allowance of taking losses temporary into account at the level of the head office, such as the Dutch system, would be a better justifiable alternative. Placing this in the light of the ruling of Marks & Spencer II, where foreign losses are imported into the domestic tax base, this conclusion is not that unexpected. A comment to this reasoning however can be made with respect to the fact that such a system of temporarily including foreign PE losses, goes further than only allowing definite losses that cannot be offset in the other state anymore.

A third case from the ECJ, Krankenheim Ruhesitz am Wannsee391 ruled that a system of tax relief for foreign permanent establishments in which losses can be taken into account at the level of the head office and in later profitable years a decreased tax relief is granted, is a justified impediment of the

389 ECJ 13 December 2005, C-446/03 (Marks & Spencer II), point 54 and 55. 390 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 391 ECJ 23 October 2008, C-157/07 (Krankenheim Ruhesitz am Wannsee).

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6. Group taxation systems and cross-border loss relief freedom of establishment in the light of the coherence of a tax system. The Dutch system, that works out similarly, can be regarded as not contrary to the freedom of establishment due to this decision.

An at last, X Holding BV392 has to be reviewed in the light of cross-border group taxation systems. As described, in X Holding BV the ECJ allowed the exclusion of foreign subsidiaries to a group taxation system. With respect to the fact that foreign entities do not have to be allowed into the groups, another reasoning can also be followed. X Holding BV is decided in the light of the Dutch tax system, the Dutch fiscal unity. If the option to enter into the fiscal unity would be extended to foreign entities, this would according to the ECJ have the effect of allowing parent companies to choose freely in which Member State the losses of their non-resident subsidiary are to be taken into account. Therefore the Dutch fiscal unity regime is regarded proportionate to the pursued objectives, even though it is an impediment to the freedom of establishment. The EUCOTAX Countries that do allow foreign subsidiaries into their group taxation schemes may be acting in line with the principle of equality from a European perspective from my point of view, even though at first sight X Holding BV would imply that allowing foreign subsidiaries into group taxation systems is not necessary. This is due to the fact that each Member State has specific rules and provisions seeing to national group taxation systems. One specific relevant Dutch provision in X Holding BV is the yearly elective regime. Since a parent company is at liberty to form or dissolve a fiscal unity each year, this would lead to a free choice for the parent company as to in which Member State losses are to be taken into account. With respect to the cross-border group taxation regimes of Autria, Italy and UK, other provisions apply. Austrian law prescribes a minimum period of three years for a group and Italy prescribes an irrevocable period of five years for a worldwide group, which becomes an irrevocable period of three years after the first five year period.393 These prescribed time periods make the group taxation regimes incomparable to the Dutch system in the sense that it is not possible to make yearly choices as to where losses are to be taken into account. The UK group relief system includes the limitation that claiming and surrendering losses is only possible if these cannot be offset in the resident state of the entity. This assures that it is not possible to randomly choose in which Member State losses can be offset.

Another earlier decision of the ECJ confirms this viewpoint, Oy AA.394 In this case on the basis of Finnish legislation an intra-group financial transfer from a domestic subsidiary to a foreign parent company was not allowed, whereas an intra-group financial transfer from a domestic subsidiary to a domestic parent company was allowed. The Court considered this different treatment to be a justified

392 ECJ 25 February 2010, C-337/08 (X Holding BV). 393 IBFD Country Guides 2010, Austria and Italy – Corporate Taxation, Group taxation. Additionally the Austrian system restricts subsidiaries from low tax countries to participate in a tax group. 394 ECJ 18 July 2007, C-231/05 (Oy AA).

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6. Group taxation systems and cross-border loss relief restriction to the freedom of establishment. The ECJ stated that the allowance of intra-group cross- border financial transfers would result in allowing groups of companies to choose freely in which Member State the profits of the subsidiary are to be taxed. This would undermine the allocation of the power to tax between the Member States. Furthermore the allowance of such cross-border financial transfers would be a risk of organizing income transfers within groups of companies, by means of purely artificial arrangements. Therefore the Finnish legislation is in line with the freedom of establishment on the basis of the combination of these two grounds of justification. Especially the last ground of justification in the Oy AA case seems comparable to the „cherry picking‟ aspect of X Holding BV. The Finnish system of intra-group transfers is not suited to allow this in cross-border situations. Groups of companies would be able to organize these intra-group transfers in such a way that profits would be taxed in countries with low tax rates and thus eroding the domestic tax base. This is however a specific mark of the Finnish legislation, it is not plainly applicable to all European systems. Measures to restrict cross-border loss relief might form a sufficient guarantee to ensure the domestic tax base.

Following this reasoning, it could be considered necessary on the basis of the European freedom of establishment to allow foreign entities in these cross-border group taxation systems. Restrictive measures regarding cross-border loss relief assure that the domestic tax base is not eroded. Especially in the light of reaching an internal market this seems the correct way of interpreting the freedom of establishment and providing justice to the principle of equality in taxation. Furthermore the inclusion of foreign subsidiaries seems a contribution to making a county an attractive business location. Additional arguments to contribute to a country‟s attractiveness as a business location are the cash flow advantage to take into account losses at an early stage and the absolute advantage if the foreign entity is not allowed to carry over and offset losses in its resident state. A disadvantage of such a cross-border group taxation system might be that cross-border losses can be offset that would not be allowed in the more territorial bound group taxation systems. This would go further than the decision in Marks & Spencer. Since not all group taxation schemes are suited to include foreign entities due to the fact that „cherry picking‟ in terms of offsetting losses would be too easy, I think the allowance of foreign entities into groups cannot plainly be obliged on the basis of the freedom of establishment. This is confirmed by the ECJ in X Holding BV. Nor does the ECJ have the authority to make such obligations. Member States are still sovereign with respect to direct taxes. It would however be desirable in the light of the internal market and the enlarged neutrality in the level playing field, to adapt present group taxation schemes or create legislation providing for a cross-border group taxation regime in countries that presently lack such a system.

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Taking these decisions from the ECJ into account, in general can be concluded that case law regarding the European law system offers little clue to the need of creating cross-border group taxation systems. Losses of foreign subsidiaries and foreign PEs do not have to be taken into account in the domestic tax base, except under specific exceptional conditions. The exclusion of cross-border loss relief is, apart from the exceptions, in line with European case law. This does not take away from the desirability of such systems in the light of the neutral level playing field.

6.4.2 Communication: ‘Tax Treatment of Losses in Cross-Border Situations’ The European Commission has stated that in order to increase the competitiveness of business in the EU, distorting measures as regards the absence of cross-border loss relief possibilities have to be removed.395 Although the Communication also entails cross-border loss relief within one company, for the purpose of this section is focussed on the possibilities for cross-border loss relief within a group of companies. The Commission states that as opposed to separate corporate entities being able to take losses into account automatically, groups of companies as such are not recognized as legal distinct entities or legal distinct taxable entities and therefore not able to take losses into account in the same way. If a Member State‟s legislation lacks cross-border loss relief for groups of companies, this can restrict the choice of the legal form of a business and the location to set up this business. The Commission however also states that, even though it would be an improvement in the light of the internal market, extending domestic group taxation systems to cross-border situations would not provide an ideal situation. Loss recapture measures would need specific provisions, as opposed to domestic losses which are recaptured automatically. This again would be difficult due to the various systems Member States apply for granting cross-border loss relief. In the text is further explained that three alternatives to create cross-border loss relief under restricted conditions are possible.

According to the Commission all of the proposals should constitute a once-only deduction of losses, only vertical upward offset of losses (thus at the level of the parent company), only a shift of income to another Member State if losses are terminal and permanent, domestic loss relief possibilities are exhausted and the systems do not offer scope for abuse. All alternatives allow the offset of losses, but differ with respect to dealing with future profits of the subsidiary at the level of the parent company. These guiding principles for the design of the three alternatives are solid and in compliance with European case law. I therefore consider this a good set of principles to keep in mind when designing the ideal cross-border group taxation system in the light of the neutral level playing field. The proposed alternatives from the European Commission consists of firstly a definite loss transfer, where

395 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final.

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6. Group taxation systems and cross-border loss relief future profits are not taken into account, secondly a temporary loss transfer, where deducted losses are recaptures and thirdly a current taxation of the subsidiary‟s results where losses are taken into account for a certain period of time.

The system I prefer most out of these three is the second one, since the first and third are most likely to be influenced by tax planning schemes. Additionally by recapturing losses, the territorial taxing power of Member States is guaranteed. An administrative argument is the fact that this system is easy to operate. This was also the approach that was chosen for the withdrawn 1990 Directive proposal.396 In order to prevent tax avoidance in this system, I think a mandatory elective time period would have to be added. Furthermore the principle of territoriality is being respected in this system, which is an advantage in my opinion in the light of states‟ tax sovereignty. An evident disadvantage of the first system is to be able to reach a certain state of neutrality, a clearing system compensating the Member State absorbing the losses is proposed. This would imply such legislation could not be implemented unilaterally. Furthermore differences in tax rates between countries would lead to difficulties. The third system consolidates results of the group entities and the credit method would have to be utilized to prevent double taxation and tax arbitrage. The lack of recapture measures however is a disadvantage of this system. A selective scheme is sensitive to tax planning, but does not have a high administrative burden. A comprehensive scheme is less sensitive to tax planning, but does have a high administrative burden.397

Thus, even though not all of the proposed systems are ideal to reach the desired neutral level playing field in my opinion, all of the proposals nevertheless contribute to the possibility of creating cross-border group taxation systems. This shows that even though in European case law the need for such a system might lack, this does not hold for the desirability of such from a broader European perspective. More so, in the Communication of the European Commission is referred to the CCCTB. The elimination of obstacles concerning cross-border loss relief is a so called targeted measure. The Commission considers it easier to develop and implement than a CCCTB, also since it can be designed unilaterally and therefore does not require harmonization. The CCCTB constitutes an European consolidated corporate tax base that would eliminate all cross-border tax barriers.398 The introduction of the CCCTB is a solution to reach an improved internal market on the long run. The aspect of removing tax barriers related to cross-border loss relief is one of the solutions that possibly

396 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final, paragraph 3.4.2. The Proposal can be found in COM(90)595 final. 397 Note that this system is comparable to the Italian worldwide consolidation system. 398 Communication of the European Commission, „Common Tax Base‟, http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_en.htm.

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6. Group taxation systems and cross-border loss relief could be achieved on the short to medium long run.399 It goes beyond the scope of this thesis to discuss the CCCTB extensively. What I want to stress here is that the desire to introduce the CCCTB stipulates the need on an European basis to develop and implement cross-border group taxation systems. This supports the idea that cross-border group taxation systems contribute to more neutrality in the level playing field.

6.4.3 Dutch announced territorial system 5 December 2009 the Dutch State secretary of Finance has sent a Letter to the Second Chamber concerning the state of affairs of possible measures in corporate income tax.400 In the Letter he announces to consider a more territorial approach as regards foreign PE losses. The present Dutch system allows foreign PE losses to be taken into account at the level of the Dutch head office. This is compensated by a recapture measure for future years of profitability for the PE. Even though this is merely a cash flow advantage, the recapture can be postponed for a long time by not generating profits in the PE. In addition to that he states it can be questioned whether it is rational to take foreign losses into account in the Dutch tax base. Furthermore it is an administrational burden on the tax authorities to keep track of losses per PE. Therefore he considers to achieve a more equal treatment of PEs and subsidiaries by adhering a more territorial approach.

On the basis of Lidl Belgium401 it is clear that it is not mandatory to take foreign PE losses into account unless these can permanently and definitely not be offset in the other State anymore. The announced territorial approach is therefore in line with European law. Furthermore the ECJ stated in Futura Participations402 that the fiscal principle of territoriality can be considered in line with European law. The strict territorial approach is however not in line with the Communication of the European Commission in 2006, wherein is stated that Member States have to restrict tax barriers as regards cross-border loss relief as far as possible. I think a more territorial approach thus does not contribute to the internal market.

A separate argument pleading against the territorial approach with respect to foreign PE losses can be found in the fact that the PE is not a separate legal entity. Although double tax treaties allocate taxing rights on a PEs income to the source state, the results are in fact part of the total entity. Losses of the foreign PE should then be included in the tax base of the total entity. In the present Dutch

399 Communication of 23 October 2001 of the European Commission, „Towards an Internal Market without tax obstacles, A strategy for providing companies with a consolidated corporate tax base for their EU-wide activities‟, COM(2001)582 final and Communication of 24 November 2003 of the European Commission, „An Internal Market without company tax obstacles achievements, ongoing initiatives and remaining challenges‟, COM(2003)726 final. 400 Letter to the Second Chamber of 5 December 2009, Stand van zaken mogeljke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14. 401 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 402 ECJ 15 May 1997, C-250/95 (Futura Participations).

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6. Group taxation systems and cross-border loss relief system, recapture measures later eliminate foreign PE losses from the Dutch tax base that have been taken into account. If losses cannot be offset to future profits anymore, and therefore not recaptured anymore, this seems in line with Marks & Spencer II403 and Lidl Belgium.

The announcement to achieve a more territorial approach as regards losses of foreign PEs is not positive in relation to the desired cross-border group taxation systems. In a cross-border group taxation system restricted cross-border loss relief would have to be possible, not only between head offices and foreign PEs, but also between parent companies and foreign subsidiaries. A territorial approach constituting an exclusion of foreign results would contradict this approach.

6.5 Group taxation systems in the neutral level playing field

Up to this point the existing group taxation systems in the EUCOTAX Countries have passed review, as well as how they relate to the principle of equality in taxation. European case law concerning group taxation systems and cross-border loss relief has also been described. This is linked to what kind of group taxation system would have to be designed in order to create more neutrality in the level playing field. In the following paragraph will be evaluated to what extent the group taxation systems of the EUCOTAX Countries are suited to contribute to the neutral level playing field. Then will be described how the ideal cross-border group taxation system should be designed.

6.5.1 Group taxation systems in EUCOTAX Countries The systems of the EUCOTAX Countries that do not know a group taxation system or have a group taxation system that is limited to domestic entities, are not suitable to reach the neutral level playing field. Domestic and foreign entities are treated unequally, since foreign entities cannot participate in these groups. These systems thus lack neutrality within the international level playing field. The second group of countries is the group that allows domestic entities and domestic PEs of foreign entities to participate in a group taxation system. The scope of neutrality regarding domestic and foreign entities in comparison to the previous group of countries is larger, but not sufficient. There is more neutrality due to the possibility for domestic PEs of foreign entities to participate in groups, but it still treats domestic entities and foreign entities differently. The participation in these group taxation system is bound by territorial limits. These systems are therefore also not suited to accomplish the best possible state of neutrality in the level playing field. Then there is a third group of countries that knows some kind of cross-border group taxation system. In these cross-border systems both domestic and foreign entities are allowed to participate.

403 ECJ 13 December 2005, C-446/03 (Marks & Spencer II).

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This implies a large amount of neutrality with respect to treating domestic and foreign entities equally. The UK system is restricted to EU/EEA entities and sees mostly to the surrendering and claiming of losses under restrictions. Other economic or civil advantages of group taxation are not included in this system. The Austrian an Italian system on the other hand allow worldwide entities. In the Austrian cross-border group taxation system profits and losses are attributed to the parent company. The system allows cross-border loss transfers, but recaptures these losses when foreign entities return to profitability. This recapture system is comparable to the Dutch recapture system for foreign PEs. By means of the restrictive provisions is accomplished that losses firstly have to be taken into account in the resident state of the entity, before permanently allowing these in the Austrian tax base. The Austrian group taxation system is however limited to one level of foreign entities. In case a foreign subsidiary holds a – foreign or domestic – subsidiary, that is a sub-subsidiary of the Austrian parent company, this sub-subsidiary is not allowed into the group.404 The Italian system allows worldwide entities into the group, based on the all out all in principle. Profits and losses of the group entities are consolidated at the level of the parent company. Granting tax relief through the credit method assures elimination of double taxation. The comprehensive element for all entities to participate prevents optimal competition in the internal market in my opinion. This element takes away the possibility for an entity to choose the most optimal structure to participate in. Neutrality is hereby not positively influenced. Tax considerations should play the least part in an entity‟s considerations regarding its business decisions. By eliminating free choice as to whether or not participate in a cross-border group taxation system, tax considerations possibly become of influence on business decisions again.

Taking this into account in general, I believe the systems of the countries that know some sort of cross-border group taxation are the most compatible with reaching the neutral level playing field. The rest of the group taxation systems are too restrictive on the basis of the narrow territorial approach, by not allowing foreign entities into the group taxation system. From the three countries with cross-border group taxation system it is an advantage that the Austrian an Italian system constitute more than just a system to take cross-border losses into account. The consolidated group approach for the profits and losses does justice to the economic and civil aspects of group approaches of companies. Furthermore both systems prescribe a minimum mandatory time period if the regime is elected. There are two aspect of the Austrian system I prefer above the Italian system. The first is the allowance of cross-border loss transfers, but recapturing these losses when foreign entities return to

404 This is called ‘die Ausschließlichkeit’: Tochterkörperschaften (Beteiligungsausmaß über 50%) von ausländischen Gruppenmitgliedern sind daher von der Unternehmensgruppe unabhängig davon ausgeschlossen, ob die Tochterkörperschaft eine inländische oder eine ausländische Gesellschaft ist. See Körperschaftsteuerrichtlinien 2001 von das Bundesministerium für Finanzen, paragraph 371, https://findok.bmf.gv.at/findok/showBlob.do;jsessionid=66BAF9E1D6DCF8BD1E89ECB32818B915?rid=146&base=GesPdf&gid=.

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6. Group taxation systems and cross-border loss relief profitability. This seems to be in line with Marks & Spencer II405 and Lidl Belgium406. The second is the possibility for entities to choose whether or not to participate in the group taxation system individually, as opposed to the all in all out principle of the Italian system. One disadvantage of the Austrian system is that only one level of foreign entities is allowed to participate in the group. This could be considered out of line with the decision from the ECJ in Papillon.407 Moreover, this disregards the „group-approach‟ as such. Since even though there might be a 100% interest in a lower tier subsidiary, it is still not allowed to participate in the group taxation.

Taking all these considerations into account, certain elements of both the Austrian and the Italian cross-border group taxation system are positive for reaching the neutral level playing field. In the following paragraph is described how the alternative desired system would be designed.

6.5.2 Desired alternative The review of case law from the ECJ regarding group taxation systems and cross-border loss relief showed that a cross-border group taxation system cannot plainly be enforced on the basis of European law. X Holding BV408 showed that foreign subsidiaries do not have to be allowed into the Dutch fiscal unity, since the yearly elective regime would make it too easy for parent companies to determine where losses are to be taken into account. The 2006 Communication of the European Commission in combination with the desire to introduce a CCCTB however stress the importance of a cross-border group taxation system in the aim to eventually achieve the optimal internal market.409 Furthermore other case law has led to certain obligations for Member States concerning cross-border loss relief.410 Losses of foreign subsidiaries have to be taken into account if these are permanent and definitely cannot be offset in the resident state of the subsidiary anymore.

The European Commission has stated a solid conceptual framework with guiding principles for alternatives for cross-border loss relief in the 2006 Communication. The Commission established that an alternative for cross-border loss relief should permit an effective and immediate once-only deduction of losses, allow losses to be taken into account at the level of the parent company, only result in a definite shift of income from one Member State to another if losses are terminal and no possibility for relief in the State where the losses are incurred, domestic loss relief possibilities have to be exhausted and not offer scope for abuse.

405 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 406 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 407 ECJ 27 November 2008, C-418/07 (Papillon). 408 ECJ 25 February 2010, C-337/08 (X Holding BV). 409 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final. 410 ECJ 13 December 2005, C-446/03 (Marks & Spencer II) and ECJ 15 May 2008, C-414/06 (Lidl Belgium).

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Keeping this in mind I would suggest to create the ideal cross-border group taxation system in the light of the neutral level playing field, by combining elements from the Austrian and the Italian group taxation system and the proposal from the European Commission where temporary loss transfers are allowed and recaptured in future profitable years. The requirements411 would come down to the following: (1) Both domestic and foreign entities are allowed to participate under strict provisions regarding percentage of shareholding and voting rights, (2) entities are individually allowed to elect to participate in the group, a selective scheme, (3) the regime is mandatory for a minimum period of time, such as 3, 5 or 10 years, (4) profits and losses are consolidated at the level of the parent company and calculated on the basis of the domestic tax law, (5) cross-border loss transfers are allowed, but recaptured in later profitable years, (6) double taxation is prevented by the credit method.

This cross-border group taxation system constitutes neutrality between domestic and foreign entities, since all are allowed to participate. By means of the elective scheme, the impact of tax considerations on business decisions is tried to be restricted to a minimum. It is unavoidable that tax considerations play a role to a certain extent. The elective element per entity however decreases this to a minimum. The mandatory time period is a means to prevent abuse. In line with X Holding BV, this disables parent companies to choose freely in which States losses are to be taken into account. The consolidated profits and losses at the level of the parent company enlarge the effective applicability of the system. An administrative disadvantage is that results of foreign entities have to be calculated on the basis of the domestic tax law, but this is meant to create neutrality between the participating entities. The fifth condition assures one of the principles as stated by the European Commission, that loss relief possibilities are firstly used and exhausted in the resident state of the foreign subsidiary. The domestic tax base is not eroded, only permanent and definite losses are taken into account. Even though this is broader than the application of Marks & Spencer II412, in the light of the neutral level playing field this is a suited measure. And at last the credit method allows countries to grant tax relief to the maximum amount of domestic tax rates.

Besides the advantages of the specific measures in the cross-border group taxation system, three more advantages can be found in this proposal. Firstly it can be implemented unilaterally by countries. This prevents the need for harmonization or unanimous decision-making, as required to create for example a Directive.413 Furthermore, the fact that it can be implemented and applied unilaterally assures that this system is not restricted to EU Member States. All states can adopt such a system.

411 These requirements have to be seen in the demarcation, indicated in paragraph 6.2. 412 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 413 Art. 115 TFEU.

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The second aspect is that this cross-border group taxation system respects the fiscal principle of territoriality. It does not take away from countries‟ taxing rights on the basis of the principle of universality or the principle of source. And last but not least, the competitive element of countries‟ tax systems is continued to be guaranteed by this cross-border loss system. Domestic tax systems of the parent companies are applied for participating entities. National systems do not have to converge, since the cross-border group taxation systems can be applied unilaterally. Hereby the tax sovereignty of states is respected.

If the proposal would be shaped into a Communication from the European Commission, it would be only applicable within the EU and it would not be enforceable by law. If it would have to be formed by a Directive, which obviously is desirable in the light of the internal market, the required unanimous decision-making might slow down the process of implementation. Ad advantage however is that it then would be enforceable by law. Furthermore would have to be looked into the options for expanding the working of such Directive benefits to third countries.

6.6 Conclusion

A legal comparison of the group taxation systems in EUCOTAX Countries is given, which varied from no group taxation system, group taxation for only domestic entities, group taxation for domestic entities and domestic PEs from foreign entities and ended with cross-border group taxation systems, some with restrictive loss relief measures. European case law on group taxation systems led to the establishment that it is justified on the basis of European law to exclude foreign subsidiaries from entering into the fiscal unity.414 The specific Dutch group taxation system is however structured by different provisions than cross-border group taxation systems that do allow foreign subsidiaries to participate in the group. In the Dutch fiscal unity regime, parent companies are yearly allowed to form or dissolve a fiscal unity. If this would be extended to foreign subsidiaries, parent companies would be able to freely choose where losses are to be taken into account. The Austrian and Italian cross-border group taxation systems both include a minimum period of respectively three and five years if the group option is chosen. This decreases the tax abuse possibilities in that respect. Furthermore the Austrian and UK cross-border group taxation system include restrictive measures as regards cross-border loss relief. Loss relief possibilities in the resident state have to be exhausted before losses can permanently be taken into account at the level of the group in another state. On the basis of this, the cross-border group taxation systems that allow foreign subsidiaries to participate might be considered in line with European law. Moreover, such systems are desirable in

414 ECJ 25 February 2010, C-337/08 (X Holding BV).

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6. Group taxation systems and cross-border loss relief the light of the internal market and the neutral level playing field with respect to the choice of the legal form.

Although case law established that the home state does not have to grant similar tax treatment to foreign subsidiaries and foreign PEs, a home state may not exclude all cross-border loss relief possibilities between entities.415 Losses of foreign subsidiaries have to be taken into account at the level of the domestic parent company if loss relief possibilities in the resident state are exhausted and will not become available in the future anymore. Furthermore Member States are allowed to exclude losses of foreign PEs from the domestic tax base.416 Advocate General Sharpston has however concluded that a system of temporary including losses of foreign PEs in combination with recapture measures for future profitable years, would be less restrictive to prevent double loss relief and provide for a balanced allocation of taxing powers of Member States.417 The Dutch State secretary of Finance has announced to consider a more territorial approach as regards losses of foreign PEs.418 A system of exclusion for losses of foreign PEs would be in line with European case law, but it is not desirable in the light of the desired neutral level playing field. It would also not contribute to the creation of a cross-border group taxation system. The European Commission has released a Communication in 2006 on the tax treatment of losses in cross-border situations.419 In order to increase competitiveness of business in the internal market, the absence of cross-border loss relief possibilities as a present tax barrier has to be removed. A cross- border group taxation system could be a contribution to eliminate restrictions as regards the choice of the legal form of a business and the location to set up a business. The Commission has stated a set of guiding principles, under which such a cross-border group taxation system has to be created. The proposed system should constitute a once-only deduction of losses, only vertical upward offset of losses (thus at the level of the parent company), only a shift of income to another Member State if losses are terminal and permanent, domestic loss relief possibilities are exhausted and the systems do not offer scope for abuse. Out of the three proposals, the one constituting the temporary offset of losses with a recapture measure for future profitable years bears recommendation. It is easy to operate, not that sensitive to tax planning schemes and can be implemented unilaterally. The cross-border group taxation system should be seen as a targeted measure in the light of the eventual development and implementation of the CCCTB. The CCCTB will only be reached in the long run, in the meantime the European Commission considers the cross-border group taxation system

415 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 416 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 417 Conclusion from Advocate General Sharpston ECJ 14 February 2008. C-414/06 (Lidl Belgium). 418 Letter to the Second Chamber of 5 December 2009, Stand van zaken mogeljke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14. 419 Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Borde Situations‟, COM(2006)824 final.

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6. Group taxation systems and cross-border loss relief a solution on a shorter run for a part of the restrictions in the internal market. More importantly, the cross-border group taxation system will contribute to more neutrality in the level playing field.

None of the EUCOTAX Countries‟ group taxation systems are perfectly fit to realize the neutral level playing field. Certain elements of the Austrian and Italian system however can be used in an alternative proposal for a cross-border group taxation system that will enlarge the neutral level playing field. The guiding principles of the European Commission are kept in mind as a framework in which the proposal is made. The proposal constitutes (1) both domestic and foreign entities are allowed to participate under strict provisions regarding percentage of shareholding and voting rights, (2) entities are individually allowed to elect to participate in the group, a selective scheme, (3) the regime is mandatory for a minimum period of time, such as 3, 5 or 10 years, (4) profits and losses are consolidated at the level of the parent company and calculated on the basis of the domestic tax law, (5) cross-border loss transfers are allowed, but recaptured in later profitable years, (6) double taxation is prevented by the credit method. In this proposal domestic and foreign entities are treated more neutral and domestic tax bases are not eroded since loss relief possibilities in resident states have to be exhausted first. Moreover, it can be implemented unilaterally, which prevents the need for harmonization. And additionally the tax sovereignty of states is respected, since national legislations do not have to converge. If the proposal would be made in the form of a Communication of the European Commission, it would have no legal binding force. In that case – and in the case it would be constructed in a Directive – would have to be investigated if the working could be expanded to third countries.

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7. Conclusion

The choice of the legal form of a business should be neutral with respect to tax law, it should be made on the basis of civil and economic aspects. The neutral level playing field with respect to legal forms constitutes justified distinctions on the one hand and equal treatment on the other hand. By this research is examined whether issues in Dutch tax law with respect to the choice of the legal form of a business are incompatible with the desired level playing field with a neutral taxation. Furthermore is examined what solutions can be provided to contribute to a more neutral taxation.

Firstly a theoretical framework, consisting of the principle of equality in taxation in constitutional law, European law, WTO law and tax treaties, was set out. The principle of equality and the non- discrimination principle embody equal treatment in equal situations and unequal treatment proportionate to the extent of situations‟ inequality. Formal laws cannot be tested to this fundamental right in Dutch constitutional law due to the ban on judicial review. An increased legal protection however exists since the precedence of international treaties and resolutions over national law. In the EU harmonization and neutralization of tax disparities is achieved through positive and negative integration. Positive integration is slowed down by the required unanimous decisions regarding direct taxes and negative integration through the ECJ is restricted to the TFEU freedoms. The freedom of establishment gives entities the right to establish themselves in the internal market without restrictions, unless an objective justification for the impediment exists. The non-discrimination principle in WTO law as represented by the most-favoured nation treatment and the national treatment rule has a very limited scope of influence on direct taxation and is therefore very limited referred to in this thesis. The non-discrimination rule in art. 24 of the OECD-MC is a national treatment rule that forbids discrimination on the grounds of nationality or residence if subjects are in equal circumstances.

Secondly the testing frame is used to evaluate whether the Dutch treatment of legal forms is in compliance with the principle of equality in taxation – or in other words is in compliance with the neutral level playing field. For this a description – based on Dutch tax law – of the treatment of corporate versus non-corporate entities and permanent establishments versus subsidiaries, is evaluated in relation to the principle of equality in taxation. It can be concluded that no neutral level playing field as regards the choice of the legal form of a business exists in the Netherlands. The description based on Dutch tax law is divided into a section on corporate versus non-corporate entities and a section on permanent establishments versus subsidiaries.

In the first section the qualification of entities and the taxation of entities are examined. Corporate personality for domestic and foreign entities is qualified by means of different methods. Material

123

7. Conclusion criteria for qualifying domestic entities are the purpose, representation, authority and liability of an entity. Formal determination of corporate personality is the civil indication of legal forms in the Civil Code. Criteria for the legal qualification of foreign entities are whether an entity can posses ownership, the liability of participants, whether an entity has a capital divided into shares and whether participations are freely transferable.420 Foreign civil law is used to determine the legal position of a foreign entity and the participants by means of these Dutch criteria. Accordingly is decided whether this foreign entity has corporate personality by Dutch standards. The Dutch qualification method for foreign entities seems in line with European law, wherein the ECJ allows Member States to classify foreign entities autonomously.421 Tax classification in the other state does not have to be taken into account. This autonomy might lead to different classifications in the case of hybrid entities, entities that have both marks of corporate and non-corporate entities. Different subjective qualification might lead to double (non-)taxation. Hence with respect to hybrid entities that can be qualified differently, a neutral level playing field lacks.

The Netherlands taxes residents on the basis of the principle of universality on the worldwide income and non-residents on the basis of the principle of source on the Dutch sourced based income. This respectively unlimited versus limited tax liability is in line with both European law and international tax law principles.422 For the results of the entity, corporate non-transparent entities are subject to corporate income tax and the participants of non-corporate transparent entities are subject to personal income tax. Shareholders of entities are firstly taxed on the basis of subjection to personal or corporate income tax and secondly on the basis of the percentage of shareholding. By evaluating this to the principle of equality in taxation is established that differences in taxation between corporate and non-corporate entities arise from the differences in the legal form. These different legal forms lead subsequently to subjection to different tax laws, corporate or income tax law. These different tax laws, including different tax base and different tax rates, have given rise to a plea in Dutch fiscal literature in favour of an income tax that is neutral with respect to the legal form of an entity. The development and implementation of a business profit tax might contribute significantly to creating enlarged neutrality within the desired level playing field for legal forms of business.

In the second section of the description is focussed on treatment of permanent establishments versus subsidiaries. In general it can be concluded that on the basis of the freedom of establishment in European law, PEs and subsidiaries are treated more and more alike. From the perspective of the host state PEs have to be treated no less favourable than subsidiaries, when they are in comparable

420 Decision of 11 December 2009, nr. CPP2009/519M. 421 ECJ 6 December 2007, C-298/05 (Columbus Container Services). 422 ECJ 15 May 1997, C-250/95 (Futura Participations).

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7. Conclusion situations regarding economic activities and subject to the same tax legislation. Different treatment can be accepted when the situations objectively justify different tax treatment. The home state may not restrict establishment of an entity in another Member State, but does not have to grant similar tax treatment to foreign PEs and foreign subsidiaries.

A subsidiary is a legal independent entity, whereas a PE is merely an extension of the entity and not a legal independent entity. The fictional separate entity approach is used for profit determination of a PE, attributing assets and liabilities based on the criterion of subservience. The civil difference between both legal forms causes different tax treatment in some situations. PEs in principle do not have access to double tax treaties, since they are not qualified as residents. PEs however became restrictedly eligible to treaty benefits due to Saint-Gobain. 423 The Dutch fiscal unity regime allows domestic entities and domestic PEs from foreign entities to enter into a group under specific requirements. The fiscal unity provides tax consolidation of the results of the joint entities at the level of the parent company. Cross-border loss relief between entities is not possible, except for losses incurred on liquidation. This is in line with Marks & Spencer II.424 Cross-border loss relief within entities is, at least temporary, possible. The Netherlands allows foreign PEs of domestic entities to offset losses at the level of the Dutch head office. These losses are compensated in future profitable years of the PE by a recapture measure in the form of granting a decreased tax relief in those years. This is an inequality between tax treatment of foreign subsidiaries and foreign PEs. Moreover, the fact that foreign subsidiaries are not allowed to participate in the fiscal unity regime and therefore cannot profit from cross-border loss relief, has led to a preliminary ruling.425 In X Holding BV is ruled that the exclusion of foreign subsidiaries to the fiscal unity is an impediment to the freedom of establishment. The measure is however justified in the light of the balanced distribution of taxing competence of Member States and considered proportionate by the ECJ. The yearly optional aspect of the fiscal unity would have the effect of allowing parent companies to freely choose in which Member States losses are to be taken into account if foreign subsidiaries would be allowed into the fiscal unity. The ECJ furthermore states that foreign PEs are not comparable to foreign subsidiaries. The system of cross-border loss relief that is granted to foreign PEs of domestic subsidiaries does therefore not have to be granted to foreign subsidiaries.

The level playing field, in which the choice between a PE or a subsidiary should be neutral as regards tax considerations, does not entirely meet the aim. With respect to inbound situations a large amount of equality between the PE and the subsidiary is established. With respect to outbound

423 ECJ 21 September 1999, C-307/97 (Saint-Gobain). 424 ECJ 13 December 2005, C-446/03 (Marks & Spencer II). 425 ECJ 25 February 2010, C-337/08 (X Holding BV).

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7. Conclusion situations this equality however is absent. The inequality mostly proceeds from civil differences between the legal forms, such as a PEs subjectivity to more than one tax jurisdiction and its lack of legal independence. To accomplish the neutral level playing field these differences do however not automatically give raise to different tax treatment.

After having established that there is no neutral level playing field with respect to the choice of the legal form of a business in the Netherlands, is examined how solutions should contribute to a more neutral taxation. By means of a legal comparison with the EUCOTAX Countries, similarities and differences between all systems have been found. With respect to two topics a more extensive research is done to create desirable alternatives to reach the neutral level playing field.

The qualification methods for foreign entities are further examined, since all countries classify entities autonomously. Double (non-)taxation in the case of differently qualified hybrid entities is a clear obstacle for a neutral level playing field. Qualification methods largely differed between countries. Some similarities could nevertheless be found. Certain countries use a preset list to classify entities, while other countries use a comparability test on the basis of domestic criteria and yet others accept foreign law for qualification for domestic tax purposes. In European law three concepts are present that could possibly serve as a solution to problems concerning double (non-)taxation and different qualification of hybrid entities. In the EC Treaty a provision was included which stated that Member States had to enter into negotiations to ensure the mutual recognition of entities as far as necessary for solving problems as a consequence of double taxation.426 This provision could not be directly called upon before court. The freedom of establishment could be considered to include the effect of this provision, since the right to exercise of this freedom is nevertheless dependent on the specific provisions referring to it. The second possible solution is the concept of mutual recognition, which means that States have to mutually recognize each others legislation. Hereby different qualifications of entities are prevented. Mutual recognition seems easier to accomplish than harmonization, since Member States‟ legislation does not have to converge. Its limit is however the restriction to the freedoms of the TFEU. The concept of mutual recognition cannot solve fiscal disparities between Member States‟ systems. The third approach is to qualify entities by means of the list to the Parent-Subsidiary Directive, upon which 27 Member States already agreed.427 Furthermore the Directive states a way to deal with different qualifications of entities. As far as entities that are included in the list, are corporate taxpayers in their resident state and qualified as transparent entities for tax purposes in the other state, the latter state should grant appropriate tax relief for the revenue that forms part of the entity‟s tax base. This can provide for a far going solution as regards hybrid entities. It does however not cover all

426 Art. 293 EC Treaty. 427 Parent-Subsidiary Directive, art. 2 and appendix (90/435/EEG).

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7. Conclusion situations, since the scope is limited to entities that are included on the list as corporate taxpayers in their resident state. By the OECD another solution is proposed, that can be implemented in double tax treaties. Qualification problems regarding hybrid entities can be solved by leaving the subjective qualification to the resident state and the objective qualification to the source state. It would provide equal treaty access as well as equal qualification of income in the double tax treaty. This can however not be enforced by law. The Netherlands also has integrated some solutions in double tax treaties concerning the qualification problem of hybrid entities. These vary from a mutual agreement procedure between authorities to prevent double taxation, to considering income of hybrid entities to be income of the partners and its result are determined as if there were a PE in the partnership‟s state, to treating income derived through a fiscally transparent person under the laws of either state as considered to be derived by a resident of the state to the extent that the item is treated as income for tax purposes in that state. None provide a solid solution that entirely is fitted to create a neutral level playing field with respect to hybrid entities. This conclusion is also valid for the methods in the EUCOTAX Countries.

A good alternative to create the desired level playing field that contains a certain state of neutrality between the legal forms of businesses is a new proposal. It would be a combination of on the one hand an uniform, easily adaptable list of qualifying entities, as either corporate or transparent, and on the other hand an instruction to accept subjective qualification of non-listed entities. The source state would be able to determine the objective qualification of income. The system can be shaped into a recommendation from the European Commission. Furthermore would have to be examined whether it can be expanded to third countries. This proposal respects the principle of territoriality concerning the qualification of entities. It implies that states have to give up a part of their sovereignty as regards the qualification of foreign entities. To create the neutral level playing field, I think this would be a good solution. A slight detail is that an entire neutral level playing field is not reached through this proposal, since disparities between states‟ qualification methods for domestic entities would still exist. It might be even more ideal from that perspective to create uniform definitions and qualification methods, but I believe states would have to give up too much sovereignty to accomplish that. This might perhaps become possible in the future though.

The second topic that is examined is the scope of group taxation systems and a way to create a group taxation system to construct a neutral level playing field with respect to the choice of the legal form. Moreover, cross-border loss relief possibilities are examined, since these clearly are an obstacle to the neutral level playing field. Existing group taxation systems vary from no group taxation system,

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7. Conclusion to group taxation for only domestic entities, to group taxation for domestic entities and domestic PEs of foreign entities and to cross-border group taxation systems, some with restrictive loss relief measures. Even though European case law has shown that under certain conditions it is allowed to exclude foreign subsidiaries from the group taxation system, this might not be the case for all cross-border group taxation systems. Aspects such as a minimum participation period and restrictive loss relief measures might sufficiently assure the balanced distribution of taxing competence of Member States and prevent tax avoidance. Furthermore European case law with respect to cross-border loss relief between entities has shown that this does not have to be allowed, except if domestic loss relief possibilities are exhausted and future possibilities to take these losses into account will not become available in the resident state of the foreign subsidiary. Additionally Lidl Belgium made clear that losses of foreign PEs may be excluded from the domestic tax base.428 This is also the approach the Dutch State secretary of Finance has announced to consider regarding the treatment of losses of foreign PEs.429 This in contrast with the present system, that allows losses to be taken into account the level of the Dutch head office temporarily. Even more so, this announced more territorial approach would not contribute to the neutral level playing field. The European Commission has released a Communication on the tax treatment of losses in cross- border situation in 2006.430 In that Communication is stated that tax barriers such as the absence of cross-border loss relief possibilities have to be removed in order to increase competitiveness in the internal market. Eventually the development and implementation of the CCCTB would eliminate tax barriers in the internal market. The solution regarding cross-border loss relief can however be seen as a targeted measure that can be achieved in a shorter time span than the CCCTB. A cross-border group taxation system could contribute to both eliminating restrictions as regards the choice of the legal form of a business and the location to set up a business. The Commission has constructed a framework of guiding principles, by means of which a cross-border group taxation system should be created. This set of guiding principles is in compliance with European case law and should be kept in mind for creating a cross-border group taxation system that is in line with the neutral level playing field. These principles are that a cross-border group taxation system should constitute a once-only deduction of losses, only vertical upward offset of losses (at the level of the parent company), only a shift of income to another Member State if losses are terminal and permanent, domestic loss relief possibilities are exhausted and the systems do not offer scope for abuse.

428 ECJ 15 May 2008, C-414/06 (Lidl Belgium). 429 Letter to the Second Chamber of 5 December 2009, Stand van zaken mogelijke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14. 430 Communication of 19 December 2006 of the European Commission, „ Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final.

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7. Conclusion

None of the EUCOTAX Countries‟ systems provide for a perfect cross-border group taxation system that entirely guarantees the neutral level playing field. Nevertheless elements of certain systems in combination with elements of the Communication of the European Commission can provide an alternative proposal for a cross-border group taxation system that will enlarge the neutral level playing field. The proposal constitutes (1) both domestic and foreign entities are allowed to participate under strict provisions regarding percentage of shareholding and voting rights, (2) entities are individually allowed to elect to participate in the group, a selective scheme, (3) the regime is mandatory for a minimum time period, such as 3, 5 or 10 years, (4) profits and losses are consolidated at the level of the parent company and calculated on the basis of the domestic tax law, (5) cross- border loss transfers are allowed, but recaptured in later profitable years, (6) double taxation is prevented by the credit method. On the basis of this proposal domestic and foreign entities are treated more neutral and the domestic tax base is not eroded, since double loss relief is restricted and additionally the mandatory time period prevents tax planning. The system can be introduced unilaterally, which prevents the need for harmonization. Furthermore national legislations would not have to converge, so states do not have to give up tax sovereignty. If the path of harmonization would however be chosen, by for instance a Directive, unanimity between 27 Member States would have to be reached. Furthermore it would then have to be examined whether the working of such a Directive could be extended to third countries. If it would be shaped into a recommendation of the European Commission, it would have no legal binding force. Concluding I think the suggested cross-border group taxation system would provide for a good solution to create an improved neutral level playing field as regards the legal form of a business.

In general this research has shown that there is no such thing as a neutral level playing field with respect to the choice of the legal form of a business, specifically regarding corporate versus non- corporate entities and permanent establishments versus subsidiaries. The EUCOTAX legal comparison made clear that between countries‟ legislations enormous gaps and differences exist. By examining what solutions could be provided to create a neutral level playing field with respect to the two selected topics, it became clear that a creating a level playing field will not be easy. Measures such as a recommendation from the European Commission on the qualification of hybrid entities and the implementation of a cross-border group taxation system might contribute. Other initiatives, such as for instance the CCCTB, might be able to contribute to creating more equality between the legal forms of businesses on the long run. A business profit tax might also be able to realize a level playing field for all different legal forms, by focussing on the generated profits instead of the legal form. Negative and positive integration offer opportunities to create a competitive internal market on a

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7. Conclusion

European level. From an international perspective such opportunities are dependent on individual countries. Before – maybe in the very distant future – uniform legislation might guarantee an entire neutral level playing field with respect to the choice of the legal form of a business, wherein tax laws are harmonized, fiscal disparities are no more, competition and business decisions depend on civil and economic considerations, there is still work to do. Until that time will have to be focussed on realizing smaller parts of the desired neutral level playing field.

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Fiscale Encyclopedie De Vakstudie, Nederlands Internationaal Belastingrecht, onderdeel 4, aantekening 8, Non-discriminatie naar nationaliteit en de vier vrijheden.

Reports

H. Kox and A. Lejour, CPB Document nr. 51, Een nieuwe WTO-ronde voor diensten, Mogelijke gevolgen voor Nederland, Centraal Planbureau 2004.

OECD, The application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, nr. 6, OECD, Paris 1999.

OECD, Application and interpretation of article 24 (non-discrimination), Public discussion draft, OECD, Paris, 2007.

OECD, Report on the Attribution of Profits to Permanent Establishment, OECD, Paris 2008.

137

Bibliography

Rapport van de belastingstudiegroep van het Katholieke Verbond van Werkgeversvakvereniging, Hervorming van de belastingheffing van ondernemingen, 1960.

A.C. Rijkers. Rapport inzake een variant van de ondernemingswinstbelasting, bijlage 2 bij Advies inzake een ondernemingswinstbelasting, Raad voor het Midden en Kleinbedrijf, ‟s Gravenhage 1995.

Report of the Ruding Committee of independent Experts on company taxation, European Comission, 1992.

Dutch Branch Report in J. Sasseville, A. Aage Skaar, and P. Baker, Is there a permanent establishment?, Amersfoort: Sdu Fiscale & Financiële Uitgevers, 2009. (Cahiers de Droit Fiscal International, Volume 94a).

Council Regulations

Council Regulation (EEC) No 2137/85 (EEIG).

Council Regulation (EEC) No 2157/2001 (SE).

Council Regulation (EC) No 1435/2003 (SCE).

Parent-Subsidiary Directive, art. 2 and appendix (90/435/EEG)

Published policy

European Commission

Communication of 14 June 1985 of the European Commission, „Completing the Internal Market: white paper from the Commission ot the European Council‟, COM(1985)310 final.

Working document of 2 June 1993 of the European Commission, „A strategic program for the internal market‟, COM/93/256/FINAL.

Recommendation of 25 May 1994 of the European Commission, no. 94/390/EG.

138

Bibliography

Communication of 23 October 2001 of the European Commission, „Towards an Internal Market without tax obstacles, A strategy for providing companies with a consolidated corporate tax base for their EU-wide activities‟, COM(2001)582 final.

Communication of 24 November 2003 of the European Commission, „An Internal Market without company tax obstacles achievements, ongoing initiatives and remaining challenges‟, COM(2003)726 final.

Communication of 19 December 2006 of the European Commission, „Tax Treatment of Losses in Cross-Border Situations‟, COM(2006)824 final.

Ministry of Finance

Decree of 21 January 2004, nr. IFZ2003/558M.

Decree of 11 January 2007, nr. CPP2006/1869M.

Decree of 11 December 2009, nr. CPP2009/519M.

Letter to the Second Chamber of 5 December 2009, Stand van zaken mogelijke maatregelen in de vennootschapsbelasting, DB2009/00674M, V-N 2009/62.14.

Kamerstukken

Kamerstukken II, 2001-2002, 28 355, nr. 2, Constitutionele toetsing, Nota 'Constitutionele toetsing van formele wetten'.

Kamerstukken II, 2003-2003, 28 746, nr. 6, Vaststelling van titel 7.13 (vennootschap) van het Burgerlijk Wetboek, Nota van wijziging.

Kamerstukken II, 2003-2004, 29 632, nr. 3. Goedkeuring van het op 8 maart 2004 te Washington tot stand gekomen Protocol, met memorandum van overeenstemming, tot wijziging van de Overeenkomst tussen het Koninkrijk der Nederlanden en de Verenigde Staten van Amerika tot het vermijden van dubbele belasting en het voorkomen van het ontgaan van belasting met betrekking tot belastingen naar het inkomen (Trb. 2004, 166), Memorie van Toelichting.

Kamerstukken II, 2006-2007, 31 058, Wet vereenvoudiging en flexibilisering bv-recht.

139

Bibliography

Kamerstukken I, 2007-2008, 28 331, nr. E, Voorstel van wet van het lid Halsema houdende verklaring dat er grond bestaat een voorstel in overweging te nemen tot verandering in de Grondwet, strekkende tot invoering van de bevoegdheid tot toetsing van wetten aan een aantal bepalingen van de Grondwet door de rechter, Nadere memorie van antwoord.

Websites

Communication of the European Commission, „Common Tax Base‟, http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_en.htm.

Körperschaftsteuerrichtlinien 2001 von das Bundesministerium für Finanzen, paragraph 371, https://findok.bmf.gv.at/findok/showBlob.do;jsessionid=66BAF9E1D6DCF8BD1E89ECB32818B91 5?rid=146&base=GesPdf&gid=. www.belastingdienst.nl/download/2440.html.

Other

Schedule of Specific Commitments, Supplement 4, revision, 18 November 1999, GATS/SC/31/Suppl.4/Rev.1.

For the legal comparison the EUCOTAX papers of the students, participating in the group with the theme „Equality and the choice of the legal form of a business‟, are used. These are the following participants: Christian Köttl (Austria), Julie Engelen (Belgium), Martin Rerolle (France), Daniel Schaber (Germany), Rosanna Natale (Italy), Monika Stokowska (Poland), Ylva Rehnman (Sweden), Yigit Bora Bozkurt (USA), Michael Gutfried (UK). Their papers are availabe on request.

140

Jurisprudence register

European Court of Human Rights

European Court of Human Rights 23 October 1990, nr. 17/1989/177/233 (Darby), BNB 1995/244.

European Court of Human Rights 22 June 1999, nr. 46757/99 (Della Ciaja vs. Italy), BNB 2002/398.

European Court of Justice

European Court of Justice 20 February 1979, C-120/78 (Cassis de Dijon).

European Court of Justice 28 January 1986, C-270/83 (Avoir Fiscal).

European Court of Justice 28 January 1992, C-204/90 (Bachmann).

European Court of Justice 13 July 1993, C-330/91 (Commerzbank).

European Court of Justice 20 October 1993, C-92/92 (Collins).

European Court of Justice 30 November 1995, C-55/94 (Gebhart).

European Court of Justice 15 May 1997, C-250/95 (Futura Participations).

European Court of Justice 12 May 1998, C-336/96 (Gilly).

European Court of Justice 27 September 1998, 81/87 (Daily Mail).

European Court of Justice 9 March 1999, C-212/97 (Centros).

European Court of Justice 29 April 1999, C-311/97 (Royal Bank of Scotland).

European Court of Justice 21 September 1999, C-307/97 (Saint-Gobain).

European Court of Justice 14 December 2000, C-141/99 (AMID).

European Court of Justice 5 November 2002, C-208/00 (Überseering).

141

Jurisprudence register

European Court of Justice 15 December 2005, C-446/03 (Marks & Spencer II).

European Court of Justice 23 February 2006, C-253/03 (CLT-UFA).

European Court of Justice 18 July 2007, C-231/05 (Oy AA).

European Court of Justice 6 December 2007, C-298/05 (Columbus Container Services).

European Court of Justice 28 February 2008, C-293/06 (Deutsche Shell GmbH).

European Court of Justice 15 May 2008, C-414/06 (Lidl Belgium).

European Court of Justice 23 October 2008, C-157/07 (Krankenheim Ruhesitz am Wannsee).

European Court of Justice 27 November 2008, C-418/07 (Papillon).

European Court of Justice 16 December 2008, C-210/06 (Cartesio).

European Court of Justice 25 February 2010, C-337/08 (X Holding BV).

Conclusion from Advocate General European Court of Justice Mischo 2 March 1999, C-307/97 (Saint-Gobain).

Conclusion from Advocate General European Court of Justice Sharpston 14 February 2008, C-414/06 (Lidl Belgium).

Conclusion Advocate General European Court of Justice Kokott 19 November 2009, C-337/08 (X Holding BV), V-N 2009/61.19.

Reference for a preliminary ruling from the Dutch Supreme Court, 21 July 2008, C-337/08 (X Holding BV).

Hoge Raad (Dutch Supreme Court)

Hoge Raad 31 December 1924, B. 3570.

142

Jurisprudence register

Hoge Raad 18 November 1931, B. 5085.

Hoge Raad 7 June 1939, B. 6925.

Hoge Raad 28 April 1954, BNB 1954/186.

Hoge Raad 4 May 1960, BNB 1960/167.

Hoge Raad 12 February 1964, BNB 1964/95 .

Hoge Raad 23 January 1974, BNB 1986/100.

Hoge Raad 24 November 1976, nr. 17998, BNB 1987/13.

Hoge Raad 6 June 1979, nr. 19290, BNB 1979/211.

Hoge Raad 9 June 1982, nr. 21142, BNB 1982/230.

Hoge Raad 1 juli 1987, BNB 1987/306.

Hoge Raad 27 January 1988, nr. 23919, BNB 1988/217 (Unileverarrest).

Hoge Raad 30 november 1988, BNB 1989/87.

Hoge Raad 14 April 1989, nr. 13822, NJ 1989, 469 (Harmonisatiewetarrest).

Hoge Raad 27 September 1989, nr. 24 297, BNB 1990/61 (Tandartsvrouwarrest).

Hoge Raad 8 November 1989, BNB 1990/36.

Hoge Raad 17 June 1992, nr. 27048, BNB 1992/295.

Hoge Raad 23 september 1992, BNB 1993/193.

Hoge Raad 1 December 1993, nr. 243, BNB 1994/64.

Hoge Raad 16 March 1994, nr. 27764, BNB 1994/191.

143

Jurisprudence register

Hoge Raad 7 May 1997, BNB 1997/263.

Hoge Raad 7 May 1997 BNB 1997/264.

Hoge Raad 28 February 2001, nr. 35557, BNB 2001/295, (Drielandenpunt).

Hoge Raad 8 February 2002, nr. 36155, BNB 2002/184.

Hoge Raad 12 July 2002, nr. 35900, BNB 2002/399.

Hoge Raad 12 July 2002, nr. 36254, BNB 2002/400.

Hoge Raad 25 November 2005, BNB 2007/117.

Hoge Raad 2 June 2006, nr. 40919, BNB 2006/288c.

Hoge Raad 11 July 2008, nr. 43484, BNB 2008/305c.

Hoge Raad 26 September 2008, nr. 43338, BNB 2009/23.

Hoge Raad 26 September 2008, nr. 43339, BNB 2009/24.

Hoge Raad 8 August 2008, BNB 2008/255.

Hoge Raad 16 January 2009, nr. 42218, BNB 2009/92.

Hoge Raad 16 January 2009, nr. 43128, BNB 2009/93.

Hoge Raad 2 October 2009, nr. 08/00900 (X BV), V-N 2009/49.22.

Conclusion from Advocate General Hoge Raad Wattel 2 June 2006, nr. 40919, BNB 2006/288c.

Conclusion from Advocate General Hoge Raad Wattel, 4 July 2007, nr. 43484, (X Holding BV), VN 20007/47.16.

144

Jurisprudence register

Note from Advocate General Wattel Hoge Raad, to ECJ 13 December 2005, C-446/03 (Marks & Spencer II), BNB 2006/72c.

Note to ECJ 27 November 2008, C-418/07 (Papillon), V-N 2008/59.20.

145

Appendix

The Wintercourse Matrix on the topic „The principle of equality in taxation & The choice of the legal form‟ from subtheme 2 is included. In succession the matrixes on corporate versus non- corporate entities, permanent establishment versus subsidiary – inbound investments and permanent establishment versus subsidiary – outbound investments are recorded. EUCOTAX Countries included in the legal comparison are Austria, Belgium, France, Germany, Italy, NL, Poland, Sweden, UK and USA.

146

Appendix

Principle of equality Principle upon. infringed not is No comparable Equality situations. some But of equality. principle No comparable no situations, criterion pertinence so possibly relevance, social on doubts fulfulled. longer no do ifN/C entities comparable, the are not even Situations No potential one). a tax not (but personality legal have as such.Discussion the on impact of equality of principle the (tax of of dividends economic taxation avoidance double regime ?), wages corporation the by tax paid the on credit for N/C directors' remuneration, improvement of N/C the flattax rate. a regime.Maybe international comparable, are not therefore no is there Situations similar tax considered impact.is rate potential A potential unrealistic. Italian the comparable are not by (decision Situations impact. potential Court). No constitutional Although tax system. comparable, are not analytic Situations their workas shareholders: for may C entities it N/C and links same are the => comparable => situation equity few A gains. capital and treatment in of dividends neutrality of (reduction adjustments made were improve to neutrality a discussion about PITthe business profits). on Heavy flatbusiness tax. potential as comparable considered are not (Constitutional Situations impact. the discussion on No potential No decision). for the dividends) (through taxation of double avoidance same However, rates tax forshareholder. business profits 19%. for individuals option as an impacts. potential No of equality. No enforceable principle differences high rates tax (profit in taxes are 26,3% very But CIT max and PIT). 55% Some adjustments made were at shareholders individual to of dividends taxation (notably listed) not is of if instead company 30% 25% the forms differencesLegal between of we business exist, and N/C companies.can find corporate characteristics within Most companies unclear. is of situations the Comparability material impactsare corporations, so little some However, No domestic of equality. principle adjustments made were (same for rate tax business profits, the 35%). Discussion on gains: capital and except dividends shareholder, forindividual the taxation of double avoidance but no serious project considered Different qualification & double (non-)taxation double & Different qualification several (sec. tax relief and BAO) 48 Unilateral real into looking provisions anti-abuse form of abuse economic legal and condition BAO) (sec.22 21, qualification objective and Subjective OECD partnership 1999 the according to report enity´s the to related Taxation France not is in because of terrioriality the qualification principle. method. deduction and Credit companiesExemption all to method given subject CIT, to treaties. tax double in tax relief Foreign foreign the in given classification the Follows forjurisdiction foreign unicorporated foreign the companies in are treated that person. legal as a jurisdiction person of foreign legal Through definition the and the credit method law. Swedish in internal given. tax credit Foreign foreign tax credit. No unilateral Foreign entities Foreign for and Directive fromList Parent-Subsidiary characteristics list comparison the on not to entities standards Austrian Outbound: 2. test (corporateLex societatis 1. law), compared criteria Lex testBelgian Fori (legal to test (to Belgian comparability Inbound: & law) entities) Characteristics comparison French to non- CIT in taxed otherwise corporate entity, Characteristics comparison German to standards are foreign entities other and of typicality Principle subject CIT and to non-transparent considered Characteristics comparison Dutch standards to as imageMirror treated foreign partnership rule: (for worldwide entity taxable is if it corporation state resident person in income) legal and criteria, person with of foreign legal Definition non-corporate considered otherwise commercialForeign 1. combination with in law form,comparison factor legal UK test to Several 2. for characteristics form ifcomparable no legal UK all secompaniesPer and corporations 1. with Elective 2. are corporations, owners limited liability entities other forsystem all Qualification of entities Qualification Domestic entities upon based is distinction the Generally, profit making aim and personality, legal of liability. level legal upon based principle in Distinction personality. legal and capacity corporate law Different Belgian meaning in the Generally tax law. Belgian in and legal the upon based is distinction profit making the and aim. personality up drawn but absent completely Distinction for of tax literature purposes. The level by factor a is of distinction. liability changing constantly Corporate: no membership, personality separate legal Non-corporate: rarely liability. personal membership, changing legal separate non of shareholders. liability personal personality Non-corporate: lack status, of legal of partners. Corporate: liability unlimited status, legal capital, perfect autonomy shares. into divided is capital code. civil are recordedin entities legal All for non-corporate Lack personality of legal into enter cannot (transparent) entities:they agreements,certain forms but binding of for opt corporate to able be will partnerships personality. and personality legal upon based Distinction structure. and personality legal upon based Distinction for obligations. of liability level the principle. Incorporation the in are listed that entities Corporate Companies unincorporated Act and partnerships. not are which associations companies traded se per and Publicly for are corporations, corporations (list) system. elective list the on not entities Different purposes meaning than for tax law purposes. non-tax law . No separate capital gains tax. gains capital No separate and are taxed at either 10%, 32.5% or 42,5%. Flat tax of rate Flat or 42,5%. 32.5% 10%, either at taxed are and th Non-corporate entities & natural persons shareholders natural & Non-corporate entities form of one in principle a countries adhere to other or the All as regarded general France, are in partnerships In transparency. subject tax the the means is but partnership the which that translucid, the and Poland France,Italy partners' level. the at tax collected is like somecorporate taxed a be to entities non-corporate allow USA entity. of rate tax 0-50%. Progressive dividends. on tax of payable also 25%, yields capital Final or 15% either at are taxed of rate Dividends tax 25-50%. Progressive tax. gains No separate capital 25%. fromThe incomefiscale 0 increases progressively for rate tax a foyer 40%. to corporate forunder can opt taxation Most entities non-corporate tax lower tax of for gains income 30.1% individuals, capital Flat tax. normal at are taxed tax rates, Dividends holdings. forrate long-period of for 40% individuals. allowance with but of rate 0-42%. MaximumProgressive oftax tax rate Reduced 45%. forrate profits available. retained amount an to of 40% only are taxed Dividends taxed be to opt may Indidivuals 42%. to 23% rate: tax Progressive ordinary corporate incomeunder follows enterprise if tax, their member a is ofindividual partnership; standards;a the accounting incomeas business income; For flatrate. all qualified 27.5% and for 12.5% at stakes 25%. taxlevied is below gains capital individuals, for of 50.28% income as regular are taxed allowance but Dividends available. is individuals 52%. to up rate Progressive asset average on fictious tax of on 4% yield based gains 30% Capital If asset of 20,315. is a EUR basic allowance with ofyear, a value the on income 25% 5%, levied is above tax stake company a in Tax: stake: 5% than More taxDividend of based 30%, gain. realised basic with ofyear, a asset value average on fictious on 4% yield tax. withholding is dividend --> of 20,315 EUR allowance from tax Progressive for flatseparate Option tax. a 19% No 32%. to 0 exemptions assets. for tax.capital Several gains chargeable capital tax. are subject dividend 19% to Dividends income income labour tax on Dual rate of tax local Progressive tax: (20%-25%) tax state Taxincome: and (28.89-34.17%) capital on are subject capital tax gains on to of 2/3 captital For individuals, 30%. income. as labour Dividends: taxed threshold certain income; a above part exceeding threshold certain 30%.Above at taxed of2/3 dividends income ascase shareholders. labour is taxed of in active Different of ratescomea credit from dividends with 50%; up to 10% 1/9 exemptionindividual per of 10,100 GBP Annual gains. on capital 18% and other exemptions as well. TaxProgressive from to 35%. 10% deductions. fewer rate but Taxlower assessed also AMT, under with tax for rate long- lower Tax Gains with for Capital Individuals Separate income. general als again then 2011, assets. Taxedheld until 15% at

Tax exemption for No separate capital gains tax. gains capital No separate . Received Dividends are exempted Dividends Received Corporate shareholders have a a have shareholders Corporate Corporate shareholders can set off dividend can setoff shareholders Corporate dividend for corporate shareholders with stake for above corporate with shareholders . Concept ofConcept taxation corporate shareholders & entities Corporate as separate tax corporate countries regard entities All corporate and the at taxation a two-layer subjects with France,some In level. corporate shareholder the the at taxed as and transparent are regarded entities hybrid certain States United the In level. owners' transparent and opaque can select between entities discussedtreatment. countries tax worldwide All income applies for residents, except France,which of territoriality.. principle the income personal on No tax. flattax;25% builds tax for 25% gains corporate entities. separate capital for final individuals, dividends, tax on yields capital forfinal not corporations. 25% corporate shareholders. subject profit-oriented not is flattax . If 33,99% entity ITLPto corporate incometax against tax. translucid but separately, are taxed entities Corporate nom (société en are corporate entities SCS) collectif, incomegeneral tax. with level owner's the at taxed incomeorporate a of tax pay entities Corporate surtax a certain plus sales exceed a if 33,33% their for businesses family The threshold. halved is tax rate for can apply small entites Corporate turnover. with taxed and owners the to apportioned profit be to their for start-ups and income personal under especially tax businesses. familiy from tax percent. five flat profitsrate; 15% incomeCorporate with tax trade local additional An computed as for individuals. tax levied. is from deriving gains substantial capital and Dividends are exempted fromshareholdings 95% to tax. incomeCorporate tax rate. 27.5% flat tax: tax income; as regular are taxed however, Dividends of for 95% corporate entities. allowance tax of for (20% Flat 25.5% profits 200.000,-). < as of part assess gains entities capital Corporate corporate income tax. tax: Dividend 5% stake, a exemption faceand above a participation 5% stake a CIT or 25.5% Dividend 20% --> below rate tax. is withholding tax of rate Flat 19% exemptions assets. forSeveral capital chargeable tax 19% on a pay to have shareholders Corporate stake has a If % company 10 of least at dividends. in subject is income unlimited and to liability tax will dividends EEA to state belonging other or Poland exempted.be IncomeCorporate Tax 26.3%. is corporate income are assessed gains within Capital tax on pay to have not do tax. Corporate shareholders stake if their exceeds 10%. dividends tax Corporate 28%. to 21% progressive tax: Slightly widely Dividends gains. capital on levied also exempted of sale on gains from as capital tax as well 10%) (> shareholdings substantial Tax flat ofProgressive rate 38%, above to 35% up $18.3m. rate but Taxlower assessed also AMT, under with tax. gains separate capital No deductions. fewer als again then 2011, until 15% at are taxed Dividends dividend can credit income. entities general Corporate corporate income their tax on tax.

147 Corporate versus non-corporate entities remarksGeneral Austria Belgium France Germany Italy Netherlands Poland Sweden UK USA Appendix

Principle of equality Principle EUCOTAX all countries deem different the legal Generally, structure of permanent and establishments hand one on as sufficient for hand argue other to a the on subsidiaries different implements treatment. France, is which One exception and of similar territoriality, treatment principle the to due a very losses for over permanent restrictsAustria carrying OECD 24 Article by overridden establishments, nowadays WTO also See of part code. tax the still but Model, non- discrimination rules. Income fromexempted for permanent investments only is establishmentsit Tax grant of corporate entities. EU Authorities problematic light in still but case of in also reciprocity, nowadays OECD Model. of 24 Article If for permanent probative establishments provide not do assessedcomparison a on similar to only are not accounts, they the on also but fortaxpayers, done resident is enterprises, like it basis ofminimum a This tax base. regime eliminated been has case in of companies EU else. (Talotta not Case), but ofBranch tax for 25% Permanent Establishments of an on avoided be Cannot likedividend. seen a corporate entity, basis of Frenchas non-discrimination the clause, Administrative been has not word last the However, has ruled. Court of Appeals of parent-subsidiary-directive? spoken Problem light this. on in permanent No, asestablishments all from of corporate entities a are 90/435/EEC of annex Directive the mentionend in company exemptfrom branch as tax well. n/a n/a assessment of double (possible) System of foreign losses of permanent that) on establishments. question later (but see implement not Did results of Marks Spencer. & raised be EUCOTAX may As other for all question countries, the if different permanent the to treatment loans of internal would one establishments justified, is though subsidiaries and assume is. it Implementation of Marks insufficient. Spencer & under for citizens US discriminationTax against allow treaties Income Model US clause (para. 4 Tax saving Convention) the Profit determination are calculated subsidiary Profits and ofPE a separate seen as is a PE similarly. generally and like subsidiary, a entity, distinct and profits as such. are losses are calculated Same as general kept has not If sufficient PE the books & subject is minimumrecords, a to PE the tax comparative as a based tax amountas well on the peers of the PE. Same as general Same as general Same as general Same as general Same as general Same as general Same as general connected" use of the "effectively Allows domestic in used law; otherwise analysis lower the on taxed can be choose to taxpayer income connected" & of "effectively income. PE to" "attributable Group taxation system Group taxation except in taxpayer, Groups one are considered requirements Additional Sweden. France and needed (share possession, sometimes residency Member group EU to join in State) one till up system Cross-border taxation group cross-border of Also foreign subsidiaries. loss level by offsetting if domesticare utilized possibilities foreign subsidiaries n/a domestic from PEs including Yes, foreign entities. state resident in losses ifpossible not Pooling domestic from PEs including Yes, foreign entities. state resident in losses ifpossible not Pooling all-out all-in Worldwide with system taxation group resident in losses ifpossible not Pooling principle. state domestic from PEs including Yes, foreign entities. state resident in results ifpossible not Pooling domestic entities) (only n/a pooling with system Cross-border taxation group state resident profits in losses ifpossible and not (foreign companies territory for Swedish only EEA) in established and subject Sweden tax in to domestic from PEs including Yes, foreign entities. Losses claimed surrendered and can be if not state resident in possible domestic entities) (only n/a Branch profit tax dividend Branch profit taxthe is amountimposed on equivalent to profits repatriated the of PE the officethe head of the foreign enterprise. n/a n/a branch profit of tax rate 25% Yes, n/a n/a n/a n/a n/a n/a branch profit of tax rate Yes, 30%. Treaty benefits for PEs Treaty residents be to considered country no are in PEs to extended and Saint-Gobain benefits by Treaty tax non-discrimination clause in by countries third treaties to extended and Saint-Gobain benefits by Treaty tax non-discrimination clause in by countries third treaties to extended and Saint-Gobain benefits by Treaty tax non-discrimination clause in by countries third treaties to extended and Saint-Gobain benefits by Treaty tax non-discrimination clause in by countries third treaties To determined be to extended and Saint-Gobain benefits by Treaty tax non-discrimination clause in by countries third treaties To determined be by benifits Treaty principle. benefits by No treaty non- to extended not but Saint-Gobain, discrimination treaties. clauses in To determined be benefits No treaty General comparisonGeneral a minimumIn general, treatment equal for is provided some though PEs, and limitations taxpayers resident fromderive lack PE's the of autonomous subjectivity. comparable. not Profit PE and taxpayers Resident tax-losstransfer setofftaxable; not restricted; limited tax liability. alike in are treated PEs and taxpayers Resident general. are and PEs treated resident taxpayers In general, alike. constituted. taxnot is to liability own For an PEs are and PEs treated resident taxpayers In general, somealike,though are provided. limitations minimumA treatment in exists: PEs of similarity level from the independency legal a are deemed have to officehead purposes. for profit attribution permanentIn general establishment resident and alike. are treated taxpayers their general, in but, tax limited liability have PEs Swedish a to provided one the treatment to equal is company. Profits PE. the to Taxation profits on attributable computed principle. separate enterprise to according are and PEs treated resident taxpayers In general, alike.Tax connected imposed income on effectively or business. The trade aimsa U.S. U.S. tax to with is that income connected way a in effectively Taxpayers. U.S. other tax on its to analogous

Permanent establishment versus subsidiary - Inbound establishmentPermanent versus investments subsidiary remarksGeneral Austria Belgium France Germany Italy Netherlands Poland Sweden UK 148USA

Appendix

Internal loans Internal loans accept internal Do not except for banks. loans. accept internal Do not loans accept internal Do not except for banks. loans. accept internal Do not loans. accept internal Do not loans. accept internal Do not loans. accept internal Do not loans. accept internal Do not loans accept internal Do not except for banks. loans. accept internal Do not PE The deemed is a require PE to certain amountof made funding up on (based of capital "free" functions, assets, risk) interest and (arm's debt bearing interest length); expenses are calculated Same Same Same Same Same Same Same Same Same Same Funding Subsidiary IfEUCOTAX a parent and money borrows company incurs expenses, those interest expenses interest are parent the by deductible ifproceeds the even company, Same Same Same Same Same Same Same Same Same Same PE DTT exempted but by Yes, Yes case of in CFC No, only DTTexempted but by Yes, Yes Yes Yes Yes Yes Yes Taxation on a currentTaxation a basis on Subsidiary No simulation general But Yes. case of in a applies rule tax a in setup subsidiary haven. case of in CFC No, only case of in CFC No, only case of in CFC No, only No No case of in CFC No, only case of in CFC No, only case of in CFC No, only PE With the in foreign PE a offset the respet to of by losses generated losses the can of domestic the wehter office,level head question the it arises,that anxious domestic the in account taken be country into lack is a there ofmight that second a source possible be of income in foreign country. the can losses of the PE treaties, tax the double accordanceIn with office head the setoff can But account. taken be into losses generaly the in utilised be cannot they case that the in only of PE foreign the have after abroad they later utilised can be If they foreign country. been taken the Austrian into account taxable in Austria already, income corrected be to has accordingly. state are or non-treaty treaty a in foreign PE a The losses by incurred treaty Lossesa exception. in incurred without deductible generally conditions. several are there but deductible principle state in are offsetan of principle, profits possible. not is territoriality the Regarding that assistance.But financial to due exception an is there But conditions. several linked to is exception offset the of world of the (Principle losses possible is Generally, factGermanincome). the that regarding But generally tax treaties can foreign PE a refer exemption to the method, by losses generated taken be cannot losses that Only account. taken be into not basically more, taken can be into any state of PE the the in account into office. of head the level the accountat permanent a establishment deductible. are Losses by incurred are results of the PE treaties, tax the double accordanceIn with form the in tax relief a granted possibility the oftax exemption a with of The account. takingoffice losses head into take can losses of the setoff be future to profits of will the they but account, into foreign PE as farPE is possible. as that The permanent the losses to establishment in incurred possible are office’s head reduceprofit the if will and Poland takein account into not is forthis method.credit the provides Otherwise, tax treaty the possible. possible. offsetAn of lossesgenerally is offoreign PE a income immediat of an world the principle offset the Regarding of losses possible. is The immediate of offsetpermanent a of level lossesthe on incurred establishment possible. is Offsetting losses Subsidiary and Withsubsidiary if a independence legal respect the to offset the of seperation, of principle the losses generated of parent the level the on corporate subsidiary a by possible not generally is company an off-setIn general, a subsidiary of losses generated by But company. of parent the level the on possible ist not system taxation because of group exception the an is there of entity an domestic also but entities only not includs that firstthe foreign 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Permanent establishment versus subsidiary - Outbound establishmentPermanent versus subsidiary investments remarksGeneral Austria Belgium France Germany Italy Netherlands Poland Sweden UK 149 USA