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The missing link

This week, all non-gooners will be pleased that I am not starting with an extended analysis of Arsenal&#39s 2001/02 season although, having just watched the Magic Hat video, we really did play some stunning football. Only a few weeks to go until we roll again, if you ignore the now downmarket-sounding Community Shield.

Anyway, last week I was looking at an important decision made by the European Court of Justice on the validity of an EU member state restricting tax exemption to dividends from companies resident in that state that had been subject to tax in that state.

As I stated last week, the UK Government seems to have been an enthusiastic supporter of the Dutch government&#39s case.

Reasonable reliance to support the argument on the limitation of the exemption to home country dividends seems to have been placed on the cases of Bachman v Belgium and EC Commission v Belgium. In these cases, differential treatment was justified on the basis that it was necessary to ensure cohesion to the tax system.

However, in those cases, a direct link existed, in respect of one taxpayer, between the grant of a tax advantage and the offsetting of that advantage by a fiscal levy, both of which related to the same tax and the same taxpayer.

In the Bachman case, which concerned insurance, there was a link between the deductibility of premiums and the taxation of sums payable by insurers under old-age insurance and life insurance policies, which it was necessary to preserve in order to safeguard the cohesion of the tax system at issue.

It was held in the case currently under consideration that no such direct link existed between, on the one hand, the grant to shareholders residing in the Netherlands of income tax exemption in respect of dividends received and, on the other hand, the taxation of the profits of companies based in another member state.

Therefore, in this case, the Bachman conditions for maintaining cohesion would not seem to have been satisfied.

However, the judgment under consideration does appear to have its validity restricted to amounts paid to “natural persons”, that is, individuals. This is interesting as the provision in question (article 1(1) of the directive) states:

“Without prejudice to the following provisions, member states shall abolish restrictions on movements of capital taking place between persons resident in member states. To facilitate application of this dir-

ective, capital movements shall be classified in accordance with the nomenclature in annex I.”

Most important, the reduction of tax revenue of the Netherlands that would occur if the Belgian dividends received were exempt was held not to be a justification for preventing the exemption from applying. The UK raised the point that if the exemption were not prevented from applying to non-Dutch dividends, then Dutch residents would be able to systematically escape tax. It was held that there would be no difference because:

The exemption on dividends was only in respect of a limited amount and

This merely meant that non-Dutch dividends were taxed in the same way as Dutch dividends.

Some may wonder whether this judgment may impact on the tax treatment in the UK of gains made by UK residents under offshore bonds compared with gains under UK bonds. The key point at issue here, in the context of the decision in this case, would appear to be that gains (admittedly not dividends) under non-UK bonds do not qualify prima facie for the basic-rate tax credit but gains under UK bonds do. Is this position contrary to article 1(1)?

Before leaping to conclusions, it should be remembered that an argument for discrimination of the sort prohibited by article 1(1) only applies in respect of EU states. In this respect, the UK law seems to have anticipated this need to avoid discrimination by including a provision in section 553(6A) ICTA 1988 that, provided the underlying funds of an EEA (which includes all EU member states) insurer bear tax at a rate of at least 20 per cent, then the basic-rate tax credit will be due in respect of the gain.

This will provide complete equivalence for UK and non-UK (EEA) policy gains in that only gains made under polices issued by insurers in jurisdictions where less than 20 per cent internal tax is due will be “discriminated” against. As to whether this limitation on conditional equivalent tax treatment is seen as something that can be challenged following this latest judgment, we shall have to wait and see.

It is as well to remember, though, that mere loss of revenue is an insufficient reason for discrimination. It may be helpful that in the case under consideration, tax was actually deducted at source at the rate of 25 per cent in Belgium.

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