European High Court Official Affirms Tax Competition

May 11, 2006

In a recent opinion to the European Court of Justice, its top legal advisor argued that laws which force companies to pay taxes on profits made by subsidiaries in other European Union (EU) countries are in violation of EU law.

The dispute arose when a U.K.-based company—Cadbury Schweppes—moved some of its operations to Ireland, which imposes a lower corporate income tax rate (see here for Tax Foundation research on international corporate income tax rates). U.K. law allows Inland Revenue to include profits from foreign subsidiaries in the U.K tax base if those subsidiaries benefit from lower tax rates in the country they are located.

In his ruling, ECJ Advocate General Phillipe Leger said that, in order to be consistent with EU law, national legislation seeking to counteract tax avoidance must target “wholly artificial arrangements” that are designed to lower tax payments without changing the nature or location of operations. In his opinion, Cadbury should be allowed to offer proof that this is not the case.

He also affirmed that “the establishment by a parent company of a subsidiary in another Member State for the purpose of enjoying the more favourable tax regime in that other State does not constitute, in itself, an abuse of freedom of establishment.”

Mr. Leger’s ruling is only preliminary, and must be approved by the full ECJ (they approve such opinions about 80 percent of the time). If they do so, it will be a major victory for the idea of tax competition in the EU.

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