Luxembourg, 21/12/2006 (Agence Europe) - In a judgment delivered on 14 December (case C 170/05), the Court of Justice states that French national legislation restricts freedom of establishment, since it makes dividends received by a non-resident parent company liable to a withholding tax, while almost fully exempting dividends received by a resident parent company. The judgment found in favour of a Dutch parent company which claimed tax discrimination against its French subsidiaries. France will, therefore, have to review its national legislation, and its bilateral agreements to ensure they comply with Community law. The judgment comes as part of the Commission's initiative to remove discrimination and double taxation (see EUROPE 9331).
Context
From 1987 to 1989, two French companies, Agro-Finances SARL and Denkavit France, paid 14.5 million French francs (FRF) by way of dividends to their parent company, Denkavit international BV, in the Netherlands. Under French law, a withholding tax of 5% of the amount of those dividends was levied, amounting to FRF 725,000. Denkavit claimed repayment of that sum before the Conseil d'Etat, which asked the Court of Justice to rule on the compatibility of the French withholding tax system with Community law.
The 5% could have been 25%, had it not been for the 1973 Franco-Netherlands convention to avoid double taxation. This convention provided that a Netherlands-resident parent company was entitled to offset the tax levied in France against the amount of tax payable in the Netherlands. But this condition, which is aimed at countering discrimination, has no effect in this case: since the parent company was exempt in the Netherlands from tax on foreign-sourced dividends, the sum previously paid to the French tax authorities had nothing to be offset against and so, in practice, could not be offset. These precise conditions benefit subsidiaries whose parent companies are established in France, and this is a restriction on freedom of establishment.
The Court of Justice took account of Member States' competence in matters relating to direct taxation, but found that Community law, which takes precedence over subsidiarity, had not been respected in this case.
Legal precedent
It seems certain that France will react, especially given that this is not the first warning on its tax system. In March 2006, the Marks & Spencer judgment gave an indication, by requiring Member States to allow losses of foreign subsidiaries to be bailed out (see EUROPE 9157). According to a French Community tax specialist, interviewed by EUROPE, this is seen by Paris as “a subsidy by the French State to failing subsidiaries abroad”. He added that, with the Denkavit judgment, “the European Court of Justice is continuing its 'unofficial' harmonisation of corporation tax within the EU”. This harmonisation brings territorial application, which is “sacrosanct” to the French into collision with the EU's more Community approach.
The Court does not require the repeal of all bilateral agreements between Member States, only those which infringe freedom of establishment. Bilateral tax conventions are, therefore, permitted, insofar as they lead to the effective removal of the effects of one principle or the other. The above-mentioned Franco-Netherlands convention, for example, would have complied if the subsidiaries involved, such as Denkavit, had been able to set off the charges as provided for.
Consequences for the French system
Even such partial erosion of French territorial tax application represents a real and immediate threat for the national treasury. The specialist contacted confirmed that the transposition of these judgments would, or rather, will effectively “do very great harm to the State”. He also noted that the Court also touched on another French Article in passing, the “mother-daughter” regime, which provides additional exoneration as a reward for a stable establishment in France. This is yet another tax source, the French tax authorities will have to do without in future.
Paris will, then, have to swallow a bitter pill, but how and when remains to be seen. When asked about this, Agnès Tessier d'Orfeuil, head of the communications unit at the Direction Générale des Impôts, the tax department, in Paris, said “all these issues are under study”, but it was too early to reveal the government's position, given that the judgment had only recently been delivered. That did not mean, she added, that there wasn't one, but no comment would be made before full assessment of the situation had been made. (cd)