The European Court of Justice (Fourth Chamber) ruled that art. 43 and 48 EC precluded national legislation under which interest payments made by a company resident in a member state to a director which was a company established in another member state were reclassified as taxable dividends, where, at the beginning of the taxable period, the total of the interest-bearing loans was higher than the paid-up capital plus taxed reserves, whereas, in the same circumstances, interest payments made to a director which was a company established in the same member state were not reclassified and so were not taxable.

Facts

A Belgian subsidiary was established and the two shareholders of the Belgian subsidiary and the parent company, established in the Netherlands, were appointed as directors. The subsidiary paid interest to the parent which was considered by the Belgian tax authorities in part to be dividends and was assessed as such.

The Belgian subsidiary brought an action before the Court of First Instance, Antwerp, which asked the ECJ to rule on the compatibility with Community law of the national law under which interest payments were not reclassified as dividends and thus were not taxable if made to a director which was a Belgian company, whereas those interest payments were reclassified as dividends, and thus taxable, if made to a director which was a foreign company.

Issue

Whether Community law precluded national statutory rules in issue.

Decision

The European Court of Justice (Fourth Chamber) (ruling accordingly) said that the national legislation introduced, as regards the taxation of interest paid by a resident company in respect of a claim to a director which was a company, a difference in treatment according to whether or not the latter company had its seat in Belgium. Companies managed by a director which was a non resident company were subject to tax treatment which was less advantageous than that accorded to companies managed by a director which was a resident company. Similarly, in relation to groups of companies within which a parent company took on management tasks in one of its subsidiaries, such legislation introduced a difference in treatment between resident subsidiaries according to whether or not their parent company had its seat in Belgium, thereby making subsidiaries of a non resident parent company subject to treatment which was less favourable than that accorded to the subsidiaries of a resident parent company. A difference in treatment between resident companies according to the place of establishment of the company which, as director, had granted them a loan constituted an obstacle to the freedom of establishment if it made it less attractive for companies established in other member states to exercise that freedom and they might, in consequence, refrain from managing a company in the member state which enacted that measure, or even refrain from acquiring, creating or maintaining a subsidiary in that member state.

It followed that the difference in treatment amounted to a restriction on freedom of establishment which was prohibited, in principle, by art. 43 and 48 EC. Such a restriction was permissible only if it pursued a legitimate objective which was compatible with the Treaty and was justified by overriding reasons of public interest. It was further necessary, in such a case, that its application was appropriate to ensuring the attainment of the objective thus pursued and did not go beyond what was necessary to attain it. A national measure restricting freedom of establishment might be justified where it specifically targeted wholly artificial arrangements designed to circumvent the legislation of the member state concerned. But the mere fact that a resident company was granted a loan by a related company which was established in another member state could not be the basis of a general presumption of abusive practices and justify a measure which compromised the exercise of a fundamental freedom guaranteed by the Treaty (see Test Claimants in the Thin Cap Group Litigation (Case C-524/04) [2007] ECR I-2107, paragraph 73).

The fact that a resident company had been granted a loan by a non resident company on terms which did not correspond to those which would have been agreed upon at arm's length constituted, for the member state in which the borrowing company was resident, an objective element which could be independently verified in order to determine whether the transaction in question represented a purely artificial arrangement, the essential purpose of which was to circumvent the tax legislation of that member state. The question was whether, had there been an arm's length relationship between the companies concerned, the loan would not have been granted or would have been granted for a different amount or at a different rate of interest. In the present case, the interest payments made by the Belgian subsidiary on a loan granted by a non resident company which was a director were reclassified as dividends because the limit laid down in the national rules had been exceeded. At the beginning of the taxable period the total of the interest-bearing loans was higher than the paid up capital plus taxed reserves. It was clear that, even if the application of such a limit sought to combat abusive practices, it went beyond what was necessary to attain that objective.

European Court of Justice (Fourth Chamber).

Judgment delivered 17 January 2008.